Fairness and Contract Design

We show experimentally that fairness concerns may have a decisive
impact on the actual and optimal choice of contracts in a moral
hazard context. Bonus contracts that offer a voluntary and
unenforceable bonus for satisfactory performance provide powerful
incentives and are superior to explicit incentive contracts when
there are some fair-minded players. But trust contracts that pay a
generous wage upfront are less efficient than incentive contracts.
The principals understand this and predominantly choose the bonus
contracts. Our results are consistent with recently developed
theories of fairness, which offer important new insights into the
interaction of contract choices, fairness and incentives.