NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Contracts as Reference Points

Oliver Hart, John Moore

NBER Working Paper No. 12706
Issued in November 2006
NBER Program(s):   CF   LE   LS

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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Document Object Identifier (DOI): 10.3386/w12706

Published: Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, MIT Press, vol. 123(1), pages 1-48, 02.

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