Contracts as Reference Points

66 Pages Posted: 12 Jan 2007

See all articles by Oliver Hart

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 noncontractible investments, and elucidates why employment contracts, which fix wage in advance and allow the employer to choose the task, can be optimal.

JEL Classification: D23, D86, K12

Suggested Citation

Hart, Oliver D. and Moore, John Hardman, Contracts as Reference Points (November 2006). Harvard Law and Economics Discussion Paper No. 572. Available at SSRN: https://ssrn.com/abstract=956999 or http://dx.doi.org/10.2139/ssrn.956999

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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United Kingdom

London School of Economics ( email )

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United Kingdom
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