Contracts as Reference Points*
- 1 February 2008
- journal article
- Published by Oxford University Press (OUP) in The Quarterly Journal of Economics
- Vol. 123 (1), 1-48
- https://doi.org/10.1162/qjec.2008.123.1.1
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 outcomes 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 wages in advance and allow the employer to choose the task, can be optimal.Keywords
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