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Fairness, Incentives and Contractual Incompleteness

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  • Schmidt, Klaus
  • Fehr, Ernst
  • Klein, Alexander

Abstract

We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned with fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

Suggested Citation

  • Schmidt, Klaus & Fehr, Ernst & Klein, Alexander, 2001. "Fairness, Incentives and Contractual Incompleteness," CEPR Discussion Papers 2790, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2790
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    1. Ernst Fehr & Klaus M. Schmidt, 1999. "A Theory of Fairness, Competition, and Cooperation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(3), pages 817-868.
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    More about this item

    Keywords

    Incentive contracts; Moral hazard; Fairness; Reciprocity; Incomplete contracts;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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