Do Incentive Contracts Undermine Voluntary Cooperation?

Abstract

In this paper we provide experimental evidence indicating that incentive contracts may undermine voluntary cooperation. This suggests that explicit incentives may have costly side effects that have been largely neglected by economists. In our experiments the undermining effect is so strong that the incentive contracts are less efficient than contracts without any incentives. Buyers, who are in the role of 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. The undermining of voluntary cooperation through incentives is, in principle, consistent with models of inequity aversion and reciprocity. Additional experiments show, however, that the reduction of voluntary cooperation through incentives is partly due to a framing effect. If the incentive is framed as a price deduction the reduction of voluntary cooperation is much stronger compared to a situation where the incentive is framed as a bonus paid on top of a base price.

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

JEL Classification: J33, J41, C91, D64