Fairness and Contract Design

Fehr, Ernst and Klein, Alexander and Schmidt, Klaus M. (November 2005): Fairness and Contract Design. SFB/TR 15 Discussion Paper No. 67

Abstract

We show experimentally that fairness concerns may have a decisive impact on the actual and optimal choice of contracts in a moral hazard context. Bonus contracts that offer a voluntary and unenforceable bonus for satisfactory performance provide powerful incentives and are superior to explicit incentive contracts when there are some fair-minded players. But trust contracts that pay a generous wage upfront are less efficient than incentive contracts. The principals understand this and predominantly choose the bonus contracts. Our results are consistent with recently developed theories of fairness, which offer important new insights into the interaction of contract choices, fairness and incentives.

• Item Type: Paper (Discussion Paper)
• Keywords: Moral Hazard, Incentives, Bonus Contract, Trust Contract, Fairness, Inequity Aversion
• Collections: Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems; Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems > A4 - Unvollständige Verträge, Marktinteraktion und soziale Vergleichsprozesse
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: C7, C9, J3
• Language: English