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ClausthalUniversityofTechnology

ToChooseorNottoChoose:Contracts,ReferencePoints,Reciprocity,andSignaling*

MATHIASERLEIANDCHRISTIANREINHOLD**

Thisversion:January2012

Abstract

HartandMoore(2008)arguethatvaryingdegreesofflexibilityincontractsinducedifferingreferencepointsandaspirationlevelsforparties’sharesofatransaction’stotalsurplus.Asaconsequence,atrade‐offbetweenadaptational flexibilityandthepreven‐tionofdistributional conflictsemerges. Ina recentpaper,Fehretal. (2011)analyzeabuyer‐seller‐relationshipwith incomplete contracts and ex anteuncertainty regardingthesellers’costleveltotesttheseeffects.Were‐runtheirexperimentandintroducean‐other treatmentwith exogenously determined contract types. Like FHZwe find refer‐encepointeffectsinbothtreatments.However,uncooperativeshadingbehaviorinourtreatments differs substantially from that described in FHZ. Furthermore, it makes asignificantdifferencewhethercontract typesaredeterminedbybuyersordeterminedexogenously.Weexplainthisbyintroducingtwofurthereffects,areciprocityeffectandasignalingeffect.

Keywords:contracts,referencepoints,experiment

JELClassification:C91,D03,D23

* WewouldliketothankEvaSchulzeHeulingforoutstandingresearchassistance.

** Email:MathiasErlei(m.erlei@tu‐clausthal.de),ChristianReinhold(crein@tu‐clausthal.de).

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TO CHOOSE OR NOT TO CHOOSE– M. ERLEI & C. REINHOLD

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1 Introduction

HartandMoore(2008)provideanewbehavioral theory for theemergenceof flexiblevs.rigidcontracts.Theyassumethatcontractualperformancedependsonwhetherthetradingpartiesareabletorealizetheprofitstheybelievethemselvestobeentitledto.Iftheyareunabletoderivethisamountofprofit, theyfeelaggrievedandare inclinedtopunishtheir tradingpartnersbynotdeliveringconsummateperformance. Indoingso,theygenerateawelfareloss.HartandMoore(2008)arguethatthroughtheirrevocablefixingofpricesundercompetitive terms,buyers’ and sellers’ aspiration levelsbecomecompatiblesothatneitheraggrievementofanytradingpartnernorthedeliveryofbadquality (“perfunctory performance” or “shading”) will occur.1 In this way, concludingcontractswithrigidtermsservestoreduceinefficiency.

However, making rigid contracts has its own drawback. Irrevocable fixing of theterms of a contractmightmake it impossible to adapt to unforeseen events. This de‐creaseswelfare.Consequently,thereexistsatrade‐offbetweenbeingabletoeffectivelyadapttonewcircumstancesandtheabilitytoavoiddistributionalconflicts.Byextend‐ingthissimplelogic,HartandMooreprovideabasisforlong‐termcontractsintheab‐sence of non‐contractable investments and an explanation of rigid employment con‐tracts.

Fehr et al. (2011) present a first experimental investigation of Hart andMoore’stheory.Atthefirststage,buyersdeterminewhethertoofferarigidoraflexiblecontract.Next,contractsareauctionedoff.Theauctiondesignensuresacompetitiveequilibriumsothatsellersacceptminimalpricesfortheirproducts.Inrigidcontracts,theseauctionpricesareirrevocableandidenticaltofinalprices.Inunfavorablecircumstancesdeter‐minedbyachancemove,thesepricesdonotallowthetradetoberealized.AccordingtoHart andMoore (2008), rigid contractswill ensure thedeliveryofhighqualityby thesellers.Incontrast,flexiblecontractsalwaysallowtrading.Thecostsofflexiblecontractsconsistofdistributionalconflictsthatareinducedbyincompatibleaspirationlevels,i.e.,subjectiveentitlementtosharesofatotalsurplus,onthepartofbuyersandsellers.Buy‐ersareallowedtoincreasepricesaboveauctionpricestoappeasesellerssothattheydonotprovide low‐qualityproducts.At the final stage, sellersdecidewhether toprovidenormalorlowquality.Notethatadeliveryoflowqualityincreasestheseller’scostssothatnosellerhasamaterialincentivetomakesuchadelivery.

By and large, the results of Fehr et al. (2011) are in line with those of Hart andMoore(2008).Thereislessshadinginrigidcontracts,althoughsellersusetheirpoten‐tial for increasingprices. Thisdefinitely supports theviewof rigid contractprices asreferencepoints.TworobustnesschecksalsosupportHartandMoore(2008):(a)reduc‐

1Hart(2009),HartandHolmstrom(2011),andHart(2011)developedatheoryofthefirmthatbasedon

thecontractsasreferencepointapproach.

TOCHOOSEORNOTTOCHOOSE–M.ERLEI&C.REINHOLD

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ingtherangeofpriceincreasesthatisfeasibleinflexiblecontractsdecreasestheprovi‐sionoflowquality(perfunctoryperformance);and(b)eliminatingthecompetitivede‐termination of (auction) prices induces a significant increase in the provision of lowquality(Fehretal.(2009)).

Fehr et al. (2011) admit that two features of their experimental results are quitesurprising.First,theyfindverylittleperfunctoryperformancewithrigidcontracts.Thisis surprising because payoffs are highly asymmetric in these cases and standardmeasuresoffairnessorinequityaversionsuggestmuchmoreperfunctoryperformance.Furthermore,theactofchoosingrigidcontractsitselfcanbeinterpretedasanuncoop‐erativebehavior thatdeservespunishmentvia thedeliveryof lowquality.Second, theunexpectednessofthisfindingisincreasedbecausethereismuchmoreperfunctoryper‐formancein flexiblecontractualrelationseventhoughthepayoffasymmetry issignifi‐cantlyreducedbybuyers’voluntaryprice increases.Fehretal. (2011)conjecture thatthiscanbeexplainedbya“newbehavioral force”:“exantecompetitionlegitimizesthetermsofthecontract,andaggrievementoccursmainlyaboutoutcomeswithinthecon‐tractandnotaboutthecontractitself.”(Fehretal.(2011),p.493)Inourjudgment,thisexplanation seems rather artificial. Do sellers reallymake such a neat distinction be‐tween“withinthecontract”and“thecontractitself”whileatthesametimenotconsider‐ingthatthebuyers’choiceofrigidcontractscausestheirprofitstodecreasesignificant‐ly?Furthermore,thechoiceofcontracttypesisbynomeansdeterminedundercompeti‐tiveconditions.

Thisiswhereouranalysisbegins.Ourmotivationforconductingourowninvestiga‐tionisbasedupontwoopenquestions:(1)whydosellersnotpunishbuyersforchoos‐ing rigid contracts? and (2)why do sellers not appreciate buyers’ voluntary price in‐creases in flexiblecontracts?To testwhetherFehretal.’s interpretationof thedata isappropriate,wereplicateFHZ’smaintreatmentandintroduceanewtreatment.Inthisnewtreatment,contracttypesarenotdeterminedbytheplayers. IfFHZareright, thischangeinexperimentaldesignshouldnothaveanimpactonsubjects’behavior.If,how‐ever,theplayers’behaviorchangessignificantly,theremustbeotherforcesatworkthanjustreferencepointeffects.

Ourmainfindingsareasfollows:(a)inthereplicationtreatmentwithendogenouscontracttypes,wefindmanymorecasesofdeliveryoflowquality(perfunctoryperfor‐mance)thanreportedinFHZ;and(b)inthecaseofexogenouslydeterminedrigidcon‐tracts, perfunctory performancedecreases substantially. Our interpretation of (a) and(b) is that the subjects in our experiment do indeed punish buyers for choosing rigidcontracts.Wecallthisareciprocityeffect.Additionally,(c)thereissignificantlylessper‐functoryperformanceif flexiblecontractsaredeterminedexogenouslythanifthebuy‐ers actively choose flexible contracts. Our interpretation of this phenomenon is thatplayers’aspirationlevelsdependnotonlyoncontracttypesbutalsoonthesignalthatbuyerssendbychoosingflexiblecontracts,whicharemorefavorabletosellers.Sellers


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thenexpecttheirtradingpartnerstobemorecooperativesothatsellers’aspirationlev‐els increasewith respect to their share of the surplus. Thiswill, in turn,make sellersmoreinclinedtoprovideperfunctoryperformanceifbuyersturnouttobelessgenerousthanexpected.We call this the signalingeffect.Nevertheless,we find (d) evidence fortheexistenceofareferencepointeffectintreatmentswithbothendogenousandexoge‐nousdeterminationofcontracttypes.

Thepaperisstructuredasfollows.InSection2,wedescribeourexperiment’sdesignandprovidedetailsregardingtheproceduresused.InSection3,wepresentthebehav‐ioralpredictions. Section4 containsour results and the relevantdiscussion. Section5concludes.

2 Experimental Design

Inthissection,wepresentourexperimentaldesignandprocedures.Weconsiderarela‐tionshipbetweenabuyerandasellerwhoareinteractingduringatwo‐periodrelation‐ship.Atdate0,theyconcludeanincompletecontractforthetradeofoneunitofawidg‐et.Theincompletenessofthecontractisduetothepossibilitythatthetrademaynotbefeasibleondate1.The feasibilitydependson thenatureof thecontractandontheexanteunknownstateofnature.Therelationship’sdynamicresemblesthe“fundamentaltransformation”describedbyWilliamson(1985).Insuchasetting,transactionpartnersbeginwithacompetitivemarketstructurethataftersomeevents,e.g.,aspecificinvest‐ment, changes into a one‐sided or bilateralmonopoly. In all treatments,wehave twodifferentkindsofcontracts,i.e.,rigidandflexiblecontracts,andthisbringsourexperi‐mentinlinewiththemodelproposedbyHartandMoore(2008).

We implemented two different treatments, an endogenous contract treatment(EndCT)andanexogenouscontract treatment (ExCT).TheEndCT iscloselyrelated tothedesignofFehretal.(2011).InourExCTweabolishthebuyers’abilitytochoosebe‐tween contract types.Each session consistsof15 suchperiods. Figure2 (given in theappendix) shows the structure of eachperiod. To facilitate subjects’ understanding oftheexperiments,wesubdividedeachperiodintosevensequentialstages:

Stage1–Formationofgroups:

Toavoidreputationaleffects,buyersandsellerswererandomlydividedintointer‐actiongroupsoftwosellersandtwobuyerseachatthebeginningofeachperiod.

Stage2–Determinationofcontracttypes:

The determination of contract types varied between the two treatments. In theEndCT,buyersdecidewhethertochoosetherigidortheflexiblecontractdesign.IntheExCT, the contract design is exogenously given to the participants. The difference be‐tweenthedesignsrelatestotheprocessofdeterminingthefinalproductprice.Inrigidcontracts, theauctionprice(Stage3) isbindingforbuyersandsellers.Furthermore, if


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thestateofnature(Stage4)turnsouttobebad,thesebindingcontractsdonotallowfortrade to be accomplished. In flexible contracts, buyers may increase product pricesabovethelevelgivenbytheauctioniftheywishtodoso,andtradeisalwaysfeasible.Table1 shows the intervals of feasible final priceswith respect to contract types andstatesofnature.

Stage3–Sellerscompeteforcontractsinclockauctions:

Afterthetwobuyersinagrouphavechosentheircontracttypes,contractsareauc‐tionedofftothesellers.JustlikeFHZ,weimplementedaninverseclockauctionwithastartingpriceof35thatisincreasedbyonepointeachsecond.Theauctionendseitherwhentheupperlimitof75isreachedorifoneofthesellersacceptsthecurrentauctionpriceby clicking abuttonon the computer screen.The first seller accepting thepricegains the contract and enters into the bilateral contract performance stages. As de‐scribedabove,thefinalpriceeitheris fixedattheleveloftheauctionprice(rigidcon‐tracts)ormayvoluntarilybeincreasedbythebuyer.Sellerswhodonotgainacontractrealizeanoutsideoptionpaymentof10points.

Todesignatrulycompetitiveauction,thesupplyofwidgetswasmadetwiceaslargeasthedemand.Moreprecisely,eachsellerisabletoproduceuptotwowidgetsperperi‐od,while buyers can buy just onewidget. Thismeans that any sellermay serve bothbuyers,whileanybuyercanonlybuyfromoneseller.Consequently,thereisanexcesssupply,whichcreatesahighlycompetitiveauctionenvironment.UnlikeinFHZ,theauc‐tions for the twopossible contracts in each group are conducted simultaneously. Theauctionboxesarerandomlyplacednext toeachotheron thecomputerscreen.Sellersarefreetoengageinanyoftheauctionsaslongasnoneofthemhasacceptedanauctionprice for the auction in question. If one of the contract prices is accepted, the corre‐spondingauctionisimmediatelyfinished.

Table1:IntervalsofFeasibleFinalPrices

Stateofnature

Contracttype Good Bad

Rigidcontract Auctionprice Notrade

Flexiblecontract [Auctionprice,140] [95,140]

Note: The auction price was determined by an inverse clock auction between the two

sellersinonegroup.Itcouldrangefrom35to75.

Stage4–Determinationofthestateofnature:

Afterthesellersandbuyershaveconcludedtheircontracts,theyareinformedaboutthe stateofnature.This statedetermines theparametersof the remainingpartof theperiod.First,ithasanimpactonsellers’costs(seeTable2).Inbadstates,sellers’costs


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increaseby60points.Inaddition,minimumfinalpricesarealsoincreasedto95.Second,thestateofnaturedetermineswhethersellersandbuyerscantradeatall.Ifbuyershavechosenrigidcontractsandabadstateemerges, tradebecomesimpossible. Inallothercases,tradewillbeaccomplished(seeTable1).Goodstatesoccurwithaprobabilityof80percentandbadstateswithaprobabilityof20percent.Intheno‐tradecase,buyersandsellersgetanoutsideoptionof10pointseach.

Table2:ExperimentalParameter

Stateofnature Good(prob=0.8) Bad(prob=0.2)

Qualityofthewidget normal low normal low

Seller’scost 20 25 80 85

Buyer’svalue 140 100 140 100

Stage5–Determinationofthefinalprice:

Theprocessofdeterminingfinalpricesdependsonthechosencontracttype.Inthecaseofrigidcontracts,participantsdonothavetomakeanydecisionsbecausethefinalpriceisgivenbytheauctionprice.Withflexiblecontracts,buyerscanvoluntarilyincreasefi‐nalpricesabovetheauctionprice(orabove95inbadstates),uptoamaximumof140(seeTable1).

Stage6–Sellerschoosequality:

Iftradetakesplace,sellershavetodetermineproductquality,whichcanbeeitherlowornormal.Irrespectiveofthestateofnature,choosinglowqualityinsteadofnormalincreasessellers’costsby5pointsanddecreasesbuyers’valueby40points(seeTable2).

Stage7–Determinationofprofits:

At theendof eachperiod,profitsaredisplayed tobuyersandsellers.Thepayoffswerecalculatedasfollows:

Sellerprofits:S=price–costs

Buyerprofits:B=value–price

TocompareourresultswiththoseofFHZ,itisnecessarytosummarizethewaysinwhichourEndCTdiffers fromtheexperimentofFHZ.First,weuseddifferent instruc‐tions,thoughtheywereofcoursesomewhatsimilartothoseofFHZ.2Asmentioned,weusedsimultaneousauctions(Stage3)insteadofsequentialauctionsbecausewewantedtoascertainwhichcontracttypeispreferredbythesellers.Finally,FHZprovidedbuyers

2Instructionsareavailableuponrequest.


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withaggregateinformationaboutaveragebuyerprofitsasanadditionaleighthstageofeachperiod.Averageprofitsweregiven separately for the twocontract typesoverallpastperiods.Thoughprovidingthisinformationfacilitateslearning,italsoweakenstheindependencyofindividualdecisionsandfosterscontagioneffects.Wefeltthatnexttothespeedofthelearningprocess,itmighthaveanimpactonthedirectionoflearning.

All sessionswere conducted in December 2008 and January 2009.We conductedtwo sessions for eachof the two treatmentswith20 subjects each (10buyers and10sellers).SubjectswerestudentsfromtheClausthalUniversityofTechnologywithmajorssuchasBusinessAdministrationorIndustrialEngineering.Tomakethemfamiliarwithourexperimentaldesign,westartedeverysessionwithtwotrainingperiodsthatwerenot remunerated. In both treatments, 45 experimental currency units (points) corre‐spondedtooneEuro.Inaddition,eachparticipantreceivedashow‐upfeeof5Euro.Onaverage,subjectsearned18.28EUR(about25.41USDatthetimeoftheexperiment).Asessionlastedforaboutoneandahalfhours.Theexperimentswerecomputerizedusingthesoftwarez‐Tree(Fischbacher2007).

3 Hypotheses

Themainmotivationforcarryingoutourexperimentisthatwepresumethatthepro‐cessofdeterminingcontracttypeshasanimpactonsubjects’behavior.Differentmodesof determining contract typesmay lead to differentmodes of behavior. In particular,sellers may be able to learn that rigid contracts decrease their expected profits andcauseanunfairdistributionofprofits.Sellersrealizingthiswillbeinclinedtointerpretthechoiceofrigidcontractsasunfriendlybehaviorthatdeservespunishmentviaprovi‐sionoflowquality.Ontheotherhand,choosingofflexiblecontractsmaybeunderstoodasasignalofcooperativebehavior.Suchasignalwill increasesellers’expectationsre‐gardingprofits.Assumingthat thiswill increasesellers’aspiration levels, lowprice in‐crementswillnotmeetsellers’aspirationlevelsandprovokeshading.Insummary,ac‐cordingtoourconsiderations,thefeasibilityofactivelychoosingcontracttypesincreas‐es the inclination to provide low quality. Consequently, replacing the active choice ofcontracttypeswithachancemovewillleadtolessshadinginbothtypesofcontractualrelationships.Keepingthisinmind,wecannowpresentourcentralhypotheses.

Aftergroupformation,thesecondstageineachperiodconsistsofdeterminingcon‐tracttypes.IntheEndCT,weexpectthesamepatternofdecisionsasreportedbyFehretal. (2011).Because there isno choicebetweencontract types in theExCT, itdoesnotmakesensetoprovideanybehavioralhypothesesregardingthisdecision.

HYPOTHESIS1(ContractChoice): Intheendogenouscontracttreatment,subjectschooserigidcontracts inabout50percentofcasesandflexiblecontractsintheremaining50percentofcases.


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AtStage2ofeachperiod,contractsareauctionedoff.Sincethereisalwaysanexcesssupply,equilibriumpricesareequaltominimumprices.FollowingFHZ,weexpecttoseedeviationsinearlyroundsduetosubjects’learning.IncontrasttoFHZ,weimplementedsimultaneousauctionsforbothbuyers’contractswithinonegroup.Thisrendersitpos‐sibletoanalyzewhichkindofcontractsellersprefer. InFHZ,sellers’profits in flexiblecontractsaresignificantlyhigherthaninrigidcontracts.Expectingasimilarpatternofprofits,sellerswillpreferflexiblecontracts.Ingroupsinwhichthereisoneauctionforrigidcontractsandoneauctionforflexiblecontracts,sellerswillthustrytogetaflexiblecontractfirstandonlyafterwardstrytogettheremainingrigidcontract.Duetothena‐tureoftheclockauction,pricesforrigidandflexiblecontractswilldifferinthesecases.

HYPOTHESIS2(AuctionPrices):

a) Inboth treatments,auctionpricesconverge toward thecompetitiveequilibri‐um,pA=35.

b) On average, prices for flexible contracts are lower than prices for rigid con‐tracts.

Whilerigidcontracts leavenoroomforpriceadjustments, flexiblecontractsallowbuyers to increase prices within the price range above the competitive lower pricebound.Thisopportunitymayaffect thesellers’shadingdecisionso that increasingthepricemay encourage sellers not to provide low quality. This price decision at date 1(Stage 5) is somewhat similar to an ultimatum game [Güth, Schmittberger, Schwarze(1982)]inwhichaproposermakesanofferregardinghowtoshareanamountofmoneywiththeresponder.Theresponderthendecideswhethertoaccepttheproposalorre‐jectit.Inthistypeofgame,rejectionsresultinapayoffofzero.Inourexperiment,buy‐ersactasakindofproposerbyofferingaparticularshareofthetotalsurplustothesell‐er.Afterthis,theseller“accepts”theofferbyprovidingnormalqualityor“rejects”itbyproviding lowquality. Unlike in the ultimatumgame, the seller can lower the buyer’sprofitbyonly40pointsinourexperiment,andhiscostsincreasebyonly5points.Inlinewith Forsythe et al. (1994),we expect that buyerswill payprices significantly higherthanthelowerpriceboundtoavoidshading.

FHZshowthatbuyersareindeedwillingtopaysignificantpriceincrementsassoci‐atedwith flexible contracts. Accordingly,we expected to find a similar pattern in theEndCT.However,behaviorrelatedtotheExCTmaydiffer.Beingabletochoosebetweencontracttypesandchoosingflexiblecontractsmayhaveanimpactonsellers’aspirationlevelsintheEndCTthatisabsentfromtheExCT.Inparticular,wepresumethatabuyerchoosingflexiblecontractssignalsapreferenceforcooperativeandfairbehavior.Thus,sellers’expectationsrise.ThissignalingeffectdoesnotexistinExCTbecausesellersdonotchoosetheircontracttypes.Consequently,sellers’aspiration levelsremainsmallersothatbuyersneedtopaysmalleramountsofmoneytopreventsellersfromshading.

HYPOTHESIS3(PriceIncrement):


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a) In both treatments, buyers pay prices that are higher than the lower priceboundinflexiblecontractsandconsequentlypriceincrementsabovezero.

b) Intheexogenoustreatment,a loweraspiration levelonthepartofthesellerscauseslowerpriceincrementsorhigheraveragequality.

AtStage6ofeachperiod,thesellerschoosewhethertoprovidelowornormalquali‐ty.ThisdecisionisatthecoreofthepapersbyHartandMoore(2008)andFHZ.Accord‐ingtothereferencepointhypothesis,rigidcontractsleavingnoroomforfurtheradapta‐tions provide a reference point onwhich both parties agree. Although profitsmay behighlyasymmetric,theexistenceofareferencepointpreventsshading.TheevidenceinFHZconfirmsthatthereislessshadinginrigidcontractsthaninflexiblecontracts.

Assumingthattheprocessofdeterminingcontracttypeshasanimpactonsubjects’behavior,weconjecturethatothereffectsbesidesthereferencepointeffectmustbeatwork.Wearguethatthepossibilityofchoosingbetweencontracttypesincreasesshad‐inginbothrigidandflexiblecontracts.Itremainsunclear,however,whetherthistreat‐ment effect is larger in rigid contracts or in flexible contracts. If shading due to thechoice of rigid contracts is smaller than shading due to unfulfilled expectations fromflexiblecontracts,Fehretal.’sresultscanbeexplainedwithoutanymentionofreferencepointeffects.Comparingshadinginbothtreatmentsmayclarifythenatureofsubjects’behavior.Accordingtothetheoryofcontractsasreferencepoints,themagnitudeofthereferencepointeffectsdoesnotdependontheprocessofdeterminingthecontracttype;instead,itonlydependsonthecontracttypeitself.Consequently,therewillbenodiffer‐encesinshadingbetweenthetreatments.If,incontrast,shadingdecreasestozerointheExCT, then the reference point hypothesismust be rejected. Finally, if shading in theExCTissmallerthanintheEndCTandifshadingunderflexiblecontractsisgreaterthanunder rigid contracts (ExCT), then all effects (reference point effects, punishment ef‐fects/reciprocitybasedonchoosingrigidcontractsandsignalingeffectsbasedonchoos‐ingflexiblecontracts)areconfirmed.Thisleadsustotwoalternativehypotheses:

HYPOTHESIS4a(PureReferencePoints):Inboth treatments, shadingwillbe close towhat itwas inFHZ, i.e., subjectswillprovidelowqualityinabouta. 6percentofcases(rigidcontracts) b. 25percentofcases(goodstatesinflexiblecontracts)c. 30percentofcases(badstatesinflexiblecontracts).

Hypothesis4aisinperfectaccordancewithHartandMoore(2008)andFHZ.Oural‐ternativehypothesisreferstotheexistenceofreciprocityandsignalingeffects:

HYPOTHESIS4b(ReciprocityandSignalingEffects):(i) Intheendogenouscontracttreatment,shadingwillbeclosetowhatitwasin

FHZ,i.e.,subjectswillprovidelowqualityin a. 6percentofcases(rigidcontracts)


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b. 25percentofcases(goodstatesinflexiblecontracts)c. 30percentofcases(badstatesinflexiblecontracts).(ii)Intheexogenouscontracttreatment,shadingwillbelowerthanintheendoge‐nouscontracttreatmentd. Ifshadingdecreasestozero,therearenoreferencepointeffects.e. Ifshadingremainsabovezeroandifthereismoreshadinginflexiblethanin

rigidcontracts,therearereferencepointeffects,reciprocityeffectsandsignal‐ingeffects.

4 Results

In this sectionwepresent anddiscuss our results. In theEndCT,we find surprisinglylarge deviations from the results presented in FHZ. Buyers choose flexible contractsmore often and pay smaller price increments. Sellers provide low qualitymore oftenthaninFHZ.Thisdifferenceinshadingislargestwithrespecttorigidcontracts.Ournewtreatmentwithcontractdeterminationbychancemovesshowsalargeshiftinbehavior.Thereislessshadingassociatedwithbothcontracttypes.Thissupportsourhypothesisthat theresultspresented inFHZarealsodrivenby factorsother thanpurereferencepointeffects.We firstpresent theresultsand thenprovideanexplanation.Ouraggre‐gateresultsarepresentedinTable8.

InsertTable8here

InFHZeachcontracttypeischosenin50percentofthecases.Table8showsthatinour sessionswith endogenous contracts, buyers reveal a clear preference for flexiblecontracts;72.3percentofthecontractswereflexible.Takingintoaccountthataveragebuyers’profitsinrigidcontracts(65.69)are(insignificantly)largerthaninflexiblecon‐tracts(61.2),thisresultbecomesevenmoreremarkable.Themoreorlessequaldistri‐butionofcontracttypesintheExCTisirrelevantherebecausecontractshavenotbeenchosenbybuyersbuthaveratherbeendeterminedexogenously.

RESULT1(ContractChoice):

Althoughaveragebuyers’profitsinflexiblecontractsaresmallerthantheirprofitsinrigidcontractstheychooseflexiblecontractsinmorethantwooutofthreecases.

Obviously,subjects’behaviorinourexperimentisdifferentfromsubjects’behaviorinFHZ.Weidentifytwopossibleexplanationsforthis.(1)We,unlikeFHZ,didnotpro‐vide subjectswithany statistical informationabout theaggregateprofitabilityof rigidand flexible contracts in the transactions of other players. Due to this lack of infor‐mation,subjectsmayhavebeenunabletoidentifythemoreprofitablecontracttype.(2)Wehadadifferentsubjectpool thanFHZ.FHZexcludedallstudentsofeconomicsand


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psychology,whereasmore than75percentofoursubjectsstudybusinessadministra‐tionorindustrialengineering.Consequently,theireducationmayhavehadanimpactontheirbehaviorinthelaboratory.Itissomewhatsurprising,however,thattheseeconom‐ically trainedparticipants favoredthe lessprofitablebut(withrespect to thedistribu‐tionofprofits)fairercontracttype.

Afterthebuyershadchosentheircontracttypes,allcontractswereauctionedofftothesellers.Theresultsof theauctionsareclose to theresults inFHZandclose toourexpectations.

RESULT2(AuctionPrices):

(a) Pricesconvergetotheequilibriumvaluep=35.

(b) Pricesforflexiblecontractsarelowerthanthoseforrigidcontracts.

Figure1showsboxplotsforauctionpricesingroupsofperiods(1‐5,6‐10,11‐15).It caneasilybeseenthat theauctionprices in the firstperiodsarewellabove35andconvergeovertimetotheequilibriumprice.Inthefinalfiveperiods,meanauctionpric‐es in EndCT and ExCT are 36.07 and 35.99, respectively. In contrast to FHZ,we heldsimultaneousauctionsofbothcontractsineachperiodandgroup.Consequently,inac‐ceptingonecontract,subjectslosttimeandcouldonlyacceptthesecondcontractafterthecorrespondingtime lag.Thisandthenormalreactiontimeofparticipantsexplainsmostofthedivergenceofpricesfromequilibriumvalues.

Figure1:AuctionPrices

30

40

50

60

70

30

40

50

60

70

1‐5 6‐10 11‐15 1‐5 6‐10 11‐15

1‐5 6‐10 11‐15 1‐5 6‐10 11‐15

Endogenous Treatment, Rigid Contracts Endogenous Treatment, Flexible Contracts

Exogenous Treatment, Rigid Contracts Exogenous Treatment, Flexible Contracts

Auction Price

Period


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Thesimultaneityofauctionsincludesanotheradvantage.Excesssupplyinmarketsforcontractsinducesintensecompetitionbetweensellerssothattheywillimmediatelyaccept contracts in equilibrium. If sellers prefer one type of contract to the other,weshould find thatsellers first try toget thiscontract typeandonlysubsequentlyaccepttheotherone.Thisimpliesthatpricesforpreferredcontractswillbelowerthanpricesfortheothercontracts.

Comparingsellers’profits shows that in flexible contracts, sellers’profits are sub‐stantially larger: sellers’mean profits under flexible contracts are 22.44 (endogenouscontracts)and24.94(exogenouscontracts);underrigidcontracts,theyearnonly15.10(endogenouscontracts)and15.91(exogenouscontracts).Thus,weexpectauctionpric‐estobelowerforflexiblecontracts.Table8showsthatpart(b)ofHypothesis2isalsosupported.Inbothtreatments,auctionpricesforflexiblecontractsareloweronaverage,and thedifference is statistically significant at the5percent level (signed rank test ofindividualmeans).

RESULT3(Priceincrement):

(a) Inbothtreatments,themeanpriceincrementsareabovezero.

(b) Meanpriceincrementsdonotdifferbetweentreatments.

There are twodifferentways to define theprice increment. First, the price incre‐ment(hereafterp35)consistsoftheadditionalpointsabovetheminimumfeasiblepriceof35intheclockauction.3However,thisdefinitiondoesnottakeintoaccountthatthecontract/auctionpriceservesasareferencepointinprinciple.Consequently,wedefinetheprice increment as the difference between the final price (chosenby the buyer atdate1)andtheauctionpriceingoodstatesofnatureor95inbadstatesofnature.Thus,thepriceincrementinrigidcontractsisalwayszero.Aslongasresult2holds,mostofthedifferencebetweenthetwodefinitionsofthepriceincrementwilldisappearinthelastperiodsoftheexperiment.

In ourpost‐experimental questionnaire,weasked the sellers to reveal theirmini‐mumpriceincrementsrequiredforabstainingfromshadingunderconditionsofaflexi‐blecontract,agoodstateofnatureandanauctionpriceof35.Onaverage,intheEndCTcase,thesellersclaim20.25points.IntheExCTcase,weobserveonlyameanpricein‐crementof10.95points. Thus, in accordwithour conjectures, the removal of buyers’responsibility for contract choice reduces sellers’ aspiration levels significantly (one‐sidedranksumtestp<0.01).However,changingtreatmentsdoesnothaveanimpactonbuyers’willingnesstopay.Inthequestionnaire,wealsoaskedhowmuchbuyerswerewillingtopaytoforecloseshadingunderconditionsofflexiblecontracts,goodstatesof

3FHZusethisdefinition.


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natureandauctionpricesof35.Onaverage,buyerswerewillingtopayupto14.35intheEndCTand14.25intheExCT.

Table3 confirmsourpost‐experimentalobservations. It shows themeanprice in‐crementwithrespecttothetwodifferenttreatments.Noneofthedifferencesbetweenthe treatments is statistically significant (one‐sidedranksumtestwithsubjectmeans,p>0.10).Thepriceincrementsare,byandlarge,thesame.Accordingly,buyers’behaviorwithrespecttopriceincrementsdoesnotappeartodependontheendogeneityorexog‐eneityofthecontracttypes.

Table3:MeanPriceIncrementsinBothTreatments

Stateofnature

Bad Good Total

Fehretal.(2011) 3.4 10.9 ‐‐‐

EndCT2.80

(4.154)10.04

(12.789)7.51

(11.135)

ExCT3.87

(4.932)11.12

(13.587)9.20

(12.326)

Notes: Standard deviations are in parentheses. A one‐sided rank sum test with subjectmeansshowsthatnoneofthedifferencesbetweenthetreatmentsisstatisticallysignificant(p>0.10).

Thedecisionofwhethertoprovidenormalorlowqualityisatthecoreofourexper‐iment. Following Hart andMoore (2008), we refer to the provision of low quality as“shading”. Ourmain research question is whether the difference in shading behaviorwithrespect tocontract typesmaynotonlybe interpretedasa referencepointeffect,butalsoasreciprocityandsignalingeffects.IfbehaviorintheExCTissignificantlydif‐ferent frombehavior in the EndCT, theremust exist some additional effects that FHZsubsumeunderreferencepointeffects.

Table 4 summarizes the shading behavior in our experiment. The first distinctivefeatureofourresultsisthatwefindmuchmoreshadingintheEndCTthanFHZdo.Inparticular,thereismoreshadinginrigidcontracts.


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Table4:ShadingBehaviorwithRespecttoTreatment,ContractType,andStateofNature

Contractstypesandstatesofnature

Rigid Flexible

Bad Good Bad Good

EndCT

(FHZ)

‐‐‐

‐‐‐

0.32

(0.06)

0.37

(0.30)

0.33

(0.25)

ExCT ‐‐‐ 0.15 0.08 0.22

Note:Numbersarerelativefrequenciesofshading.NumbersinparenthesesrepresentthecorrespondingrelativefrequenciesofshadinginFHZ.

Evenmore importantly, there areonly small differences in shadingbetween rigidandflexiblecontracts.Noneofthesesmalldifferencesisstatisticallysignificant(signedranktestofsubjectmeans).IntheEndCT,shadinginrigidcontractsandgoodstatesisjustslightlysmallerthaninflexiblecontractsandgoodstates.ComparedtotheFHZre‐sults,referencepointeffectsseemtoberathersmallforoursessions.

Things are somewhat different in the ExCT. Compared to endogenous contracts,shadingissubstantiallyandsignificantlysmaller inallcombinationsofstatesandcon‐tracttypes(one‐sidedranksumtest;p<0.05).Furthermore,ingoodstates,thereislessshading in rigid contracts than in flexible contracts.Our results clearly contradictHy‐pothesis4a(purereferencepoints)andsupportHypothesis4b.

RESULT4:

(i) In the endogenous contract treatment, shadingbehavior isnot close towhatwasevidencedinFHZ.Subjectsprovidelowqualityin a. 32percentofcases(rigidcontracts) b. 33percentofcases(goodstatesinflexiblecontracts)c. 37percentofcases(badstatesinflexiblecontracts).

(ii) Intheexogenouscontracttreatment,shadingislowerthanintheendogenouscontract treatment. Furthermore, shading remains above zero, and there ismoreshadinginflexiblethaninrigidcontracts.

Itisremarkablehowmuchmoreshadingwefindinrigidcontractswhencomparedto the resultsofFHZ.Thismight raisedoubts concerning thevalidityof the referencepointhypothesis.However,ithastobetakenintoaccountthatpricesunderflexiblecon‐tractsarehigherthanthoseunderrigidcontractssothatthereislessofanincentiveforsellerstoshade.InTable5,wepresentrelativefrequenciesofshadingfordifferentpriceintervals.To compareprices indifferent states, price increments (p35) aredefinedas


‐15‐

finalpricesminusminimalfeasibleprices, i.e.,pricesminus35ingoodstatesorpricesminus95inbadstates.Table5showsthatforallbutoneinterval,shadinginrigidcon‐tracts and good states is less than shading in flexible contracts and good states. Thissupportsthereference‐point‐effecthypothesis(RPE).

Table5:ShadingUnderDifferentPriceIntervals

Priceincre‐ments(p35)

EndogenousContracts ExogenousContracts

Rigid Flexible Rigid Flexible

Bad Good Bad Good Bad Good Bad Good

p35=0 .333 .488 .409 .091 .125 .333

0<p35≤5 .313 .200 .404 .191 .000 .308

5<p35≤10 .385 .100 .412 .231 .167 .071

10<p35≤15 .000 .667 .188 .000 .000 .200

15<p35 .000 .205 .000 .156

Note:Numbersarerelativefrequenciesofshading.

Our results indicate that itmakes a differencewhether contracts are determinedendogenouslyorexogenously.Endogenouslydeterminedrigidcontractsclearlyresultinmore shading than exogenously determined contracts. When sellers had to decidewhethertoshadeornot,theonlydifferencebetweenthetwotreatmentswasthatbuy‐ershadconsciouslydetermined thecontract typeso that theywereresponsible for it.Ourinterpretationoftheincreaseinshadingisthusthatsellerspunishedbuyersforse‐lectingtheincorrecttypeofcontract.This, inturn, isnothingmorethannegativereci‐procity(RecE)andaffectsshadingbehaviorintheoppositedirectionofreferencepointeffects.

Theendogenouschoiceofacontracttypeincreasesshadinginflexiblecontracts,aswell.Becauseweregardadecisioninfavorofaflexiblecontractasasignalthatincreas‐estheaspirationleveloftheseller,itwouldseemthatlowpriceincrementsdisappointsellerssuchthattheyaremoreinclinedtopunishbuyers(SigE).Table6summarizesourtheoryaboutthethreeeffects.


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Table6:TheoreticalEffects

RigidContracts FlexibleContracts

EndogenousContractsRPE:

RecE:

–

+

RPE:

SigE:

+

+

ExogenousContracts RPE: – RPE: +

Note:RPEdenotesthereferencepointeffect,RecEthereciprocityeffectandSigEthesignalingeffect.Thesigns“+”and“–“indicatethatthecorrespondingeffectincreases(+)ordecreases(–)shading.

AccordingtoTable6,andaslongasthereciprocityeffectisnottoolarge,shadingishighestinthecaseofflexibleandendogenouscontractsandlowestinthecaseofrigidandexogenouscontracts.Theremainingtwocases,rigidendogenouscontractsandflex‐ibleexogenouscontracts,aresomewhereinbetween.Itisexanteunclearwhichofthesetwocaseswillhavemoreshading.Thesehypothesesaresupportedbythesubjects’be‐haviorasshowninTable5.

To conduct amore rigorous test,we performed some econometric estimations ofshadingbehavior. Inourdataset,shading isgivenbythebinomialvariableshading. Itequals1 in thecaseof shadingandzero incaseofnormalquality.Finalpricescanbeseparatedintoauctionprices(priceauc)andpriceincrements(priceinc).4Table6showsthat thereferencepointeffect is thesame forendogenousandexogenouscontracts. Itrefersonlytothechoiceofcontracttype.FlexCisthecorrespondingvariable(1forflex‐ible contractsandzero for rigidcontracts).The reciprocityeffect appliesonly to rigidandendogenous contracts.Thebinomial variable endorigid covers this effect.This in‐teractivevariableis1forrigidcontractsintheEndCTandzerootherwise.Thesignalingeffect occurs only in flexible endogenous contracts. The corresponding variable(endoflex)equals1inthesecasesandzerootherwise.Accordingtoourtheoreticalcon‐siderations,shadingincreasesinFlexC,endorigidandendoflex.

Table7showstheresultsofourestimations.Thedependentvariableinallregres‐sionsisshading.Thefirstestimationincolumn2servesasourbenchmarkestimation.5Letusfirstlookatthebenchmarkmodel,arandomeffectslogitmodelwithfewcontrolvariables.Column2showsthatthecoefficientsofFlexC,endorigidandendoflexareallsignificantatthe5‐percentlevel.Theirsignsareallpositive.Therefore,ourresultscor‐roboratetheexistenceofallthreeeffects,i.e.,thereferencepointeffect,thereciprocity 4Priceincmustnotbeconfusedwithp35inTable5.5Thequalitativeresultsofourestimationdonotdependonthemethodofestimationandtheinclusionof

furthercontrolvariableslikestateofnature,sex,age,andperiod.Weconductedprobitestimations,popu‐

lationaverageestimations,pooledlogitestimationsandOLSestimationswithsimilarresults.


‐17‐

effect and the signalingeffect. Furthermore, the coefficientsof endorigid andendoflexarehigherthanthecoefficientofFlexC,indicatingthatthesignalingandreciprocityef‐fectsareasleastasimportantasthereferencepointeffect.Thecoefficientofpriceincissignificantlylessthanzero,meaningthatbuyerscandecreasetheprobabilityofshadingbyincreasingthefinalprice.

Table7:RandomEffectLogitRegressionsandSocialPreferences

Variable ModelI ModelII ModelIII ModelIV ModelV ModelVI

FlexC .819(.031)

.828(.031)

.767(.039)

.744(.047)

.642(.067)

.756(.045)

endorigid 1.11(.046)

1.11(.046)

1.113(.044)

1.122(.044)

1.127(.043)

1.12(.045)

endoflex 1.24(.015)

1.24(.016)

1.232(.016)

1.22(.017)

1.191(.019)

1.219(.017)

priceinc ‐.0807(.000)

‐.087(.012)

‐.059(.001)

‐.060(.003)

‐.051(.005)

‐.070(.041)

goodstate .630(.024)

.801(.203)

.330(.188)

.600(.269)

reci_unfair

‐.003(.425)

.0099(.035)

‐.005(.382)

ia_shade

.899(.064)

1.157(.012)

.911(.062)

constant ‐2.86(.000)

‐2.78(.000)

‐3.052(.000)

‐3.47(.000)

‐3.399(.000)

‐3.34(.000)

N 525 525 525 525 525 525LL ‐249.3 ‐249.3 ‐249.7 ‐248.1 ‐248.5 ‐248.1LL(0) ‐280 ‐280 ‐280.1 ‐279 ‐279.3 ‐279R2;R2,ps .110 .110 .109 .111 .110 .111

Notes:dependentvariable,shading;p‐values(one‐sidedtest)inparentheses;N,numberofobservations;LL,log‐likelihood.

Finally,wefindsignificantlymoreshadingingoodstates.Thismaybeexplainedac‐cordingtotwofactors.First,thereissimplylessscopeforpriceincrementsinbadstates

(140– 95)thaningoodstates(140– auctionprice140– 35).Consequently,compara‐tivelymodestprice increments inbad states lookmoregenerous thando largerpriceincrements ingoodstates.Second, thedistributionofpayoffs ismoreunequal ingoodstates than inbadstates.Forexample, if thebuyerchoosesaprice incrementof15 inbadstates,thetwoplayers’payoffsareidentical.Ingoodstates,however,thesamepriceincrementinduceshighlyunequalpayoffs,i.e., 90and 30.6

6Hereweassumetheauctionpricetobe35,theequilibriumprice.


‐18‐

Thusfar,ourresultsareeconomicallyandstatisticallysignificant.Webelieve,how‐ever,thatduetothehighlyasymmetricpayoffsinourexperiment,itisnecessarytotestwhether additional variables characterizing social preferences or fairness preferenceshaveanimpactonourmainresults.Wemeasuresuchsocialpreferencesintwovaria‐bles.Thefirstone,reci_unfair,measuresthedifferencebetweenthebuyer’sandthesell‐er’shypotheticalprofitsinthecaseofhigherbuyerprofit,assumingthatthesellerdoesnotshade.Oursecondvariable,ia_shade,isabinomialvariablewithdirectreferencetothemodelsofinequalityaversionreportedbyFehrandSchmidt(1999).GiventheutilityfunctionofFehrandSchmidt,

max , 0 max , 0 ,

and assuming that 0.5, we calculated whether shading is utility‐maximizinginthesenseofFehrandSchmidt.7Thevariableequals1whenevershadingmaximizesutility,andequalszerootherwise.

Table7alsoshowstheresultsoftheseestimations.ModelIisthebenchmarkmodelagain.InModelIIandModelIV,wesimplyaddoneofthenewvariablesforsocialpref‐erences.ModelVI includes both variables.Model II andModelV substitute the corre‐spondingsocialpreferencevariableforthestatevariable.

The introductionof thenewvariableshashardlyanyimpactonthecoefficientsofFlexC,endorigidandendoflex,i.e.,thevariablesatthecoreofourpaper.Themagnitudesofthecoefficientsremainbyandlargeunchangedandstatisticallysignificant.Again,theexistenceofreferencepointeffects,reciprocityeffectsandsignalingeffectsisconfirmed.Likewise,thereisnosubstantialeffectonthecoefficientofpriceinc.Incontrast,thecoef‐ficientofthestatevariableishighlysensitivetotheintroductionofthevariablesforso‐cial preferences. The coefficients of all three variables, i.e., good_state, reci_unfair andia_shade,arestatisticallysignificantatthefivepercentlevelwhentheyareincludedex‐clusively.Whentheyarejointlyincludedwithoneothervariableorboth,onlyia_shaderemainsweaklysignificant(atthetenpercentlevel).Thissensitivityisduetothehighdegreeofcorrelationbetweenthesevariablesand,inparticular,betweengood_stateandreci_unfair( .68).

Summarizingtheresultsoftheregressionanalysis,wecanstateourfinalresult.

RESULT5:

Accordingtotheresultsofpanelregressions,wefindthat there isevidence for theexistenceof referencepointeffects, reciprocityef‐

fectsandsignalingeffects; allthreeeffectsareofasimilarorderofmagnitude;

7Becauseofthelargepayoffasymmetriesinourexperiment,wehadtoselectratherlowvaluesfor and

.Otherwise,inequality‐averseplayerswouldshadeinvirtuallyallcases.


‐19‐

theresultsarerobustwithrespecttothevariablesincludedandtheestima‐tionmethods;

the variables referring to distributional fairness, i.e., reci_unfair andia_shade,contributetotheexplanationofsubjects’behavior.

5 Conclusion

Inthispaper,weprovideasecondexperimentaltestofHartandMoore’s(2008)behav‐ioraltheoryofcontracts.HartandMoore’smainmessageisthatrigidcontracttermsandparticularly rigidpricesmayserveas referencepoints that canpreventexpost ineffi‐ciencies causedby incompatible subjective entitlements. In thispaper,we find resultsdeviatingsignificantly fromthoseof the first testpresentedbyFehretal. (2011).FHZprovide remarkable support forHart andMoore (2008). However, they admit to findsomeothersurprisingresults.Inparticular,theyfindnoevidenceofnegativereciprocitydue to buyers’ uncooperative choices regarding contract types and surprisingly littleremuneration for buyers’ voluntary increases of contract prices. Because we regardtheir explanation as rather unconvincing, after having performed a replication treat‐ment,weintroduceanewtreatmentinwhichbuyerscannolongerdeterminecontracttypes.Inthenewtreatment,contracttypesareexogenouslydeterminedbytheexperi‐menter. According to Fehr et al.’s interpretation of their data, this change in experi‐mentaldesignshouldnothavean impactonbehavior.Wefind,however,thatthenewdesign results in a substantial change in behavior. Furthermore, subjects’ behavior inreplicatingsessionsdifferssignificantlyfromthebehaviorofsubjectsinFHZ.

First, we findmore shading than FHZwith respect to endogenously chosen rigidcontracts.Weregardthisincreasedshadingasthe(negative)reciprocityeffectthatFHZaresurprisednottofind:sellerspunishbuyersforchoosingrigidcontractsanddecreas‐ingsellers’payoffs.Thiseffectissolargethatshadinginoursessionsisapproximatelythesameinendogenouslyrigidandendogenouslyflexiblecontracts.

Second,determiningcontracttypesexogenously,aswedoinournewtreatment,re‐sults in a decrease in shading of approximately 50 percent for both rigid and flexiblecontracts.Consequently,we findthat itdoesmakea largedifferencewhethercontracttypesarechosenbytheplayersthemselves,andthatFehretal.’s interpretationof thedataseemstobeincomplete.Thedecreaseinshadingunderrigidcontractscanbeex‐plainedbytheomissionofthereciprocityeffectbecausebuyersarenolongerresponsi‐bleforcontracttypes.Weinterpretthedecreaseinshadingwithflexiblecontractsastheomissionofasignalingeffect.Thissignalingeffect,whichworksinthecaseofendoge‐nouscontracts,stemsfromthepossibleinterpretationofsellersthatchoosingofflexiblecontractsmay signalmore cooperativebehavior on thepart of buyers. This signal in‐creasessellers’aspirationlevels.Atanyrate,Fehretal.’sconjecturethat“aggrievement


‐20‐

occurs mainly about outcomes within the contract and not about the contract itself”(Fehretal.(2011),p.497)isnotsupportedbyourdata.

Third,wealso findevidence for the existenceof referencepoint effects.Theseef‐fectsaremanifest in the smaller shading in rigid contractswhencompared to flexiblecontracts,givenfinalpricesandtreatments.Fourth, inourexperiment,referencepointeffectsareofasmallermagnitudethaninFHZ.Inparticular,theyaresmallerthanthetreatment effects. Fifth, we find evidence for the relevance of social preferences andfairnessconsiderationswithrespecttopayoffasymmetries.

Insummary,wefindthatitisnotonlycontracttypesandtheircorrespondingrefer‐ence point effects that determine sellers’ shading behavior, but also the process bywhichcontract typesareselected. Inourexperiment,sellers take intoaccountbuyers’behavioratallstagesof theexperimentalgame,whileFehretal. (2011) findevidenceonlyofthefeasiblepricerangethatremainsaftertheauctionphaseandmaycauseag‐grievementandperfunctoryperformance.

HartandMoore(2008)andFHZemphasizethattheexistenceofreferencepointef‐fectsisdependentonexantecompetition.Accordingtobothpapers,pricesdonotserveas referencepointswithoutexante competition.However, theexperimentaldesignofFHZestablishesonlyone‐sidedcompetitionandgivesallmarketpower to thebuyers.Thereisnocompetitionbetweenbuyersatall.Webelievethatthisdoesnotreallycor‐respond to the fundamental transformation as put forward by Williamson (1985).Therefore,aDoubleAuctioninsteadofthesellerauctionmightbeabettertestofHartandMoore’stheoreticalapproach;however,thismustbeleftforfutureresearch.

Finally,inmanyexperiments,wefindthatenvironmentsinwhichsubjectshavelit‐tleornoinformationabouttradingpartners’payoffsresultinbehaviorthatisclosertothestandardeconomicapproach.Becauseinformationabouttradingpartners’payoffsisoften highly incomplete in real life, it remains to be seen whether the actual experi‐mental results also carryover to such situations.Again, this questionmustbe left forfutureresearch.


‐21‐

References

Fehr,E.,Hart,O.,andZehnder,C.(2009):“Contracts,ReferencePoints,andCompetition–BehavioralEffectsoftheFundamentalTransformation”,JournaloftheEuropeanEco‐nomicAssociation,7(2‐3):561‐572.

Fehr,E.,Hart,O.,andZehnder,C.(2011):“ContractsasReferencePoints–ExperimentalEvidence”,AmericanEconomicReview,101(2),493‐525..

Fehr,E.,andSchmidt,K.(1999):“ATheoryofFairness,Competition,andCooperation”,QuarterlyJournalofEconomics,114(3),817‐868.

Fischbacher, U. (2007): “z‐Tree: Zurich Toolbox for Ready‐made Economic Experi‐ments”,ExperimentalEconomics,10(2),171‐178.

Forsythe,R.L.,Horowitz,J.,Savin,N.E.,andSefton,M.(1994):“Fairnessinsimplebar‐gaininggames”,GamesandEconomicBehavior,6,347‐369.

Güth,W.,Schmittberger,R.,andSchwarze,B.(1982):“Anexperimentalanalysisofulti‐matum bargaining”, Journal of EconomicBehavior andOrganization, 3(4), 367‐388.

Hart, O. (2009) “Noncontractible Investments and Reference Points”,mimeo,HarvardUniversity.

Hart,O.(2011)“Hold‐Up,AssetOwnership,andReferencePoints”,QuarterlyJournalofEconomics,124(1),267‐300.

Hart,O.,andB.Holmstrom(2010):“ATheoryofFirmScope”,QuarterlyJournalofEco‐nomics,125(2),483‐512.

Hart,O.,andMoore,J.(2008):“ContractsasReferencePoints”,QuarterlyJournalofEco‐nomics,123(1),1‐48.

Williamson,O.(1985):“TheEconomicInstitutionsofCapitalism”,NewYork:FreePress.


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Appendix

Table8:AggregateResults

Treatment EndogenousContracts ExogenousContracts

ContractType Rigid Flexible Rigid Flexible

Rel.Freq.ofContracts .277 .723 .48 .52

AuctionPrice(mean) 38.69 37.41 38.44 37.03

FinalPrice(mean) 38.6947.57/97.8

38.4448.38/98.87

Rel.Freq.oflowquality .322 .341 .147 .184

ProfitBuyer(mean) 65.69 61.2 73.12 70.88

ProfitSeller(mean) 15.1 22.44 15.91 24.94


‐23‐

Figure2:StructureofEachPeriod

1. Formation of

groups 2. Buyer determines

contract type 3. Sellers compete for

contracts 4. State of nature is

determined 5. Buyer chooses the

price 6. Seller chooses

quality 7. Profit calculation

rigid contract flexible contract

bad bad good good

80 % 20 %

No trade

Buyer and seller got 10 points as outside option

Auction price pSt3

Buyer choose price

95 p 140

Buyer choose price

pSt3 p 140

Value

Cost

140

80

100

85

140

20

100

25

140

20

100

25

80 % 20 %

no. low low low no. no.

Legend: low – low quality no. – normal quality pSt3 – auction price

Dat

e 0

- C

ontr

acti

ng

Dat

e 1

- T

rade

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