Contracts as Reference Points

66 Pages Posted: 14 Nov 2006  

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

John Moore

University of Edinburgh - Economics; London School of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: November 2006

Abstract

We argue that a contract provides a reference point for a trading relationship: more precisely, for parties' feelings of entitlement. A party's ex post performance depends on whether he gets what he is entitled to relative to outcomes permitted by the contract. A party who is shortchanged shades on performance. A flexible contract allows parties to adjust their outcome to uncertainty, but causes inefficient shading. Our analysis provides a basis for long-term contracts in the absence of non-contractible investments, and elucidates why "employment" contracts, which fix wage in advance and allow the employer to choose the task, can be optimal.

Keywords: contracts, reference points, entitlements, aggrievement

JEL Classification: D23, D86, K12

Suggested Citation

Hart , Oliver and Moore, John, Contracts as Reference Points (November 2006). Available at SSRN: https://ssrn.com/abstract=944784 or http://dx.doi.org/10.2139/ssrn.944784

Oliver D. Hart (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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John Hardman Moore

University of Edinburgh - Economics ( email )

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London School of Economics ( email )

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