DP2790 Fairness, Incentives and Contractual Incompleteness

Author(s): Ernst Fehr, Alexander Klein, Klaus M. Schmidt
Publication Date: May 2001
Keyword(s): Fairness, Incentive Contracts, Incomplete Contracts, Moral Hazard, Reciprocity
JEL(s): C70, C90, J30
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2790

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.