The John M. Olin Center

Paper Abstract

572. Oliver Hart & John Moore, Contracts as Reference Points, 12/2006. subsequently published in Quarterly Journal of Economics, Vol. CXXIII, Issue 1, February 2008, 1-48.

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 outcome 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 wage in advance and allow the employer to choose the task, can be optimal.

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