Contracts, Fairness, and Incentives

We show experimentally that fairness concerns may have a decisive
impact on both the actual and the optimal choice of contracts in a
moral hazard context. Explicit incentive contracts that are optimal
according to self-interest theory become inferior when some agents
value fairness. Conversely, implicit bonus contracts that are
doomed to fail among purely selfish actors provide powerful
incentives and become superior when there are some fair-minded
players. The principals understand this and predominantly choose
the bonus contracts, even preferring a pure bonus contract over a
contract that combines the enforcement power of explicit and
implicit incentives. This contract preference is associated with
the fact that explicit incentives weaken the enforcement power of
implicit bonus incentives significantly. Our results are largely
consistent with recently developed theories of fairness, which also
offer interesting new insights into the interaction of contract
choices, fairness and incentives.