Citation:
Hart, Oliver, and John Moore. 2008. “Contracts as Reference Points.” Quarterly Journal of Economics CXXIII (1): 1-48.
QJE-2008 | 320 KB |
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 ineffi- cient 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.