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

  • Suren Basov EMAIL logo and M. Ishaq Bhatti
Published/Copyright: April 11, 2013
The B.E. Journal of Theoretical Economics
From the journal The B.E. Journal of Theoretical Economics Volume 13 Issue 1

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.

Acknowledgments

This research is supported by ARC Discovery grant DP0881381 “Mechanism design under bounded rationality: The optimal contracts in the complex world.” The authors are grateful to Ivan Marinovic for the comments on the earlier draft of this paper. They are also grateful to an anonymous referee, all the participants of La Trobe University Department of Finance Workshop, and in particular to Damien Eldridge, for the comments on the latest version.

  1. 1
  2. 2

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

  3. 3

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

  4. 4

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

  5. 5

    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*.

  6. 6

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

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Published Online: 2013-4-11
Published in Print: 2013-1-1

©2013 by Walter de Gruyter Berlin / Boston

Articles in the same Issue

  1. Masthead
  2. Masthead
  3. Advances
  4. Dependence and Uniqueness in Bayesian Games
  5. Monopolistic Signal Provision†
  6. Multi-task Research and Research Joint Ventures
  7. Transparent Restrictions on Beliefs and Forward-Induction Reasoning in Games with Asymmetric Information
  8. A Simple Bargaining Procedure for the Myerson Value
  9. On the Difference between Social and Private Goods
  10. Optimal Use of Rewards as Commitment Device When Bidding Is Costly
  11. Labor Market and Search through Personal Contacts
  12. Contributions
  13. Learning, Words and Actions: Experimental Evidence on Coordination-Improving Information
  14. Are Trust and Reciprocity Related within Individuals?
  15. Optimal Contracting Model in a Social Environment and Trust-Related Psychological Costs
  16. Contract Bargaining with a Risk-Averse Agent
  17. Academia or the Private Sector? Sorting of Agents into Institutions and an Outside Sector
  18. Topics
  19. Poverty Orderings with Asymmetric Attributes
  20. Dictatorial Mechanisms in Constrained Combinatorial Auctions
  21. When Should a Monopolist Improve Quality in a Network Industry?
  22. On Partially Honest Nash Implementation in Private Good Economies with Restricted Domains: A Sufficient Condition
  23. Revenue Comparison in Asymmetric Auctions with Discrete Valuations
https://doi.org/10.1515/bejte-2012-0011

Articles in the same Issue

  1. Masthead
  2. Masthead
  3. Advances
  4. Dependence and Uniqueness in Bayesian Games
  5. Monopolistic Signal Provision†
  6. Multi-task Research and Research Joint Ventures
  7. Transparent Restrictions on Beliefs and Forward-Induction Reasoning in Games with Asymmetric Information
  8. A Simple Bargaining Procedure for the Myerson Value
  9. On the Difference between Social and Private Goods
  10. Optimal Use of Rewards as Commitment Device When Bidding Is Costly
  11. Labor Market and Search through Personal Contacts
  12. Contributions
  13. Learning, Words and Actions: Experimental Evidence on Coordination-Improving Information
  14. Are Trust and Reciprocity Related within Individuals?
  15. Optimal Contracting Model in a Social Environment and Trust-Related Psychological Costs
  16. Contract Bargaining with a Risk-Averse Agent
  17. Academia or the Private Sector? Sorting of Agents into Institutions and an Outside Sector
  18. Topics
  19. Poverty Orderings with Asymmetric Attributes
  20. Dictatorial Mechanisms in Constrained Combinatorial Auctions
  21. When Should a Monopolist Improve Quality in a Network Industry?
  22. On Partially Honest Nash Implementation in Private Good Economies with Restricted Domains: A Sufficient Condition
  23. Revenue Comparison in Asymmetric Auctions with Discrete Valuations
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