Fairness, Incentives and Contractual Incompleteness

42 Pages Posted: 1 Mar 2001

See all articles by Ernst Fehr

Ernst Fehr

University of Zurich - Department of Economics

Alexander Klein

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics

Klaus M. Schmidt

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

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Date Written: March 2001

Abstract

We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned about fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

Keywords: Incentive Contracts, Moral Hazard, Fairness, Reciprocity, Incomplete Contracts

JEL Classification: C7, C9, J3

Suggested Citation

Fehr, Ernst and Klein, Alexander and Schmidt, Klaus M., Fairness, Incentives and Contractual Incompleteness (March 2001). CESifo Working Paper Series No. 445, Zurich IEER Working Paper No. 72, Available at SSRN: https://ssrn.com/abstract=262015

Ernst Fehr

University of Zurich - Department of Economics ( email )

Blümlisalpstrasse 10
Zuerich, 8006
Switzerland
+41 1 634 3709 (Phone)
+41 1 634 4907 (Fax)

Alexander Klein

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany
+49 89 2180 3907 (Phone)
+49 89 2180 3510 (Fax)

Klaus M. Schmidt (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany
+49 89 2180 3405 (Phone)
+49 89 2180 3510 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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