Internal and external reference dependence of incomplete contracts: Experimental evidences

The ex-ante incomplete contract is considered a reference point for trading parties and hence affects their ex-post performances (Hart and Moore 2008). Nonetheless, parties may engage in social comparison and use the prices of external market trades to form feelings of entitlement within their contr...

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Bibliographic Details
Published inJournal of economic behavior & organization Vol. 203; pp. 189 - 209
Main Authors Feng, Jun, Ho, Chun-Yu, Qin, Xiangdong
Format Journal Article
LanguageEnglish
Published Elsevier B.V 01.11.2022
Subjects
Contracts
Laboratory experiments
Reference points
Reference points
D86
Laboratory experiments
C92
J41
Contracts
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Summary:The ex-ante incomplete contract is considered a reference point for trading parties and hence affects their ex-post performances (Hart and Moore 2008). Nonetheless, parties may engage in social comparison and use the prices of external market trades to form feelings of entitlement within their contract. Our experimental investigation finds that the external market price shapes parties’ feelings of entitlement in both rigid and flexible contracts. We further propose a model that allows subjects’ decisions to depend on the external market price and ex-ante contractual price. We then structurally estimate the model and find that the external market price affects sellers’ performance even if it is within the contractual price range. This finding supplements the theory of Hart and Moore (2008). In particular, sellers weigh the external market price and their contractual price almost the same in forming their reference points, and hence these factors affect sellers’ decisions and payoffs similarly.
ISSN:0167-2681
1879-1751
DOI:10.1016/j.jebo.2022.09.009