Do Incentive Contracts Crowd Out Voluntary Cooperation?

Abstract

In this paper we provide experimental evidence indicating that incentive contracts may cause a strong crowding out of voluntary cooperation. This crowding-out effect constitutes costs of incentive provision that have been largely neglected by economists. In our experiments the crowding-out effect is so strong that the incentive contracts are less efficient than contracts without any incentives. Principals, nonetheless, prefer the incentive contracts because they allow them to appropriate a much larger share of the (smaller) total surplus and are, hence, more profitable for them.

Keywords: Incentive contracts, reciprocity, incomplete contracts, voluntary cooperation, experiments

JEL Classification: C91, D64, J41