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The B.E. Journal of Theoretical Economics

Editor-in-Chief: Schipper, Burkhard

Ed. by Fong, Yuk-fai / Peeters, Ronald / Puzzello , Daniela / Rivas, Javier / Wenzelburger, Jan

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1935-1704
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Optimal Contracting Model in a Social Environment and Trust-Related Psychological Costs

Suren Basov / M. Ishaq Bhatti
Published Online: 2013-04-11 | DOI: https://doi.org/10.1515/bejte-2012-0011

Abstract

Most research in contract theory concentrated on the role of incentives in shaping individual behavior. Recent research suggests that social norms also play an important role. From a point of view of a mechanism designer (a principal, a government, and a bank), responsiveness of an agent to the social norms is both a blessing and a curse. On the one hand, it provides the designer with extra instruments, while on the other it puts restrictions on how these new and the more conventional instruments can be used. The main objective of this paper is to investigate this trade-off and study how it shapes different contracts observed in the real world. We consider a model in which agent’s cost of cheating is triggered by the principal’s show of trust. We call such behavior a norm of honesty and trust and show that it drives incentives to be either low powerful or high powerful, eliminating contracts with medium powerful incentives.

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About the article

Published Online: 2013-04-11

Published in Print: 2013-01-01


See, for example, Kandel and Lazear (1992), Barron and Gjerde (1997), Che and Yoo (2001), Huck and Rey-Biel (2006), and Huck, Kübler, and Weibull (2010).

Such agents were called as post-conventional according to Kohlberg’s (1984) classification of stages of moral development.

This corresponds to behavior of a conventional agent according to Kohlberg (1984).

We are grateful to an anonymous referee for bringing this paper to our attention.

One might object to the fact that the psychological cost is symmetric around e*. Note, however, that at equilibrium the agent will never exert effort higher than promised, so the results will not change if the psychological cost is zero for e > e*.

These results require some simple calculations that are, however, standard and are omitted.


Citation Information: The B.E. Journal of Theoretical Economics, Volume 13, Issue 1, Pages 271–284, ISSN (Online) 1935-1704, ISSN (Print) 2194-6124, DOI: https://doi.org/10.1515/bejte-2012-0011.

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