Working Paper: NBER ID: w12706
Authors: Oliver Hart; John Moore
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.
Keywords: Contracts; Reference Points; Entitlement; Performance
JEL Codes: D23; D86; K12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Contract provides a reference point (K12) | Parties' feelings of entitlement (P14) |
| Parties' feelings of entitlement (P14) | Performance (D29) |
| Feeling shortchanged (Y60) | Shade performance (Y10) |
| Shade performance (Y10) | Deadweight loss (H21) |
| Contract structure (L14) | Performance outcomes (L25) |
| External perceptions of fairness (D63) | Entitlement (H55) |
| External perceptions of fairness (D63) | Performance (D29) |