Contracts as Reference Points


Hart, Oliver, and John Moore. 2008. “Contracts as Reference Points.” Quarterly Journal of Economics CXXIII (1): 1-48.
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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.

Last updated on 12/04/2012