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Optimal Contracting With Boundedly Rational Agents

Author

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  • Manfred K÷nigstein

    (Humboldt-University of Berlin, Institute for Economic Theory III, Berlin, Germany)

Abstract

Principal-agent theory usually assumes that the players are perfectly rational. In contrast, real human decision makers are only boundedly rational. If a firm (principal) wants to design a work contract that maximizes profit, it should consider how workers (agents) will actually react rather than how they should react if they were perfectly rational. In this paper the data of a principal-agent experiment are used to estimate the agents' probability of accepting an offeredá contract as well as the expected effort choice. Both empirical acceptance and effort behavior reject the assumption of perfectly rationality. Estimation results are used to illustrate the problem of optimal contracting. It turns out that profit maximization calls for offering intermediate incentive contracts rather than high incentive contracts. Furthermore, agents should be offered a considerably higher income than the outside option value.

Suggested Citation

  • Manfred K÷nigstein, 2001. "Optimal Contracting With Boundedly Rational Agents," Homo Oeconomicus, Institute of SocioEconomics, vol. 18, pages 211-228.
    • Handle: RePEc:hom:homoec:v:18:y:2001:p:211-228
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    Cited by:

    1. Simon Gächter & Manfred Königstein, 2009. "Design a Contract: A Simple Principal-Agent Problem as a Classroom Experiment," The Journal of Economic Education, Taylor & Francis Journals, vol. 40(2), pages 173-187, April.
    2. Simon Gächter & Manfred Königstein, 2009. "Design a Contract: A Simple Principal-Agent Problem as a Classroom Experiment," The Journal of Economic Education, Taylor & Francis Journals, vol. 40(2), pages 173-187, April.

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