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date: 16 February 2020

Abstract and Keywords

This article investigates the relationship between formal contracts and trust. The results from Grosskopf and Roth (2009) reveal that experimental investigations of contract design ideally need to be conducted in varying negotiation environments with ample opportunities for learning. The standard approach to the enforcement of contracts derives incentive compatibility constraints under the assumption of fully rational and selfish individuals. In Fehr, Klein, and Schmidt (2007), and Fehr, Kirchsteiger, and Gaechter (1997), firms were restricted to use either a bonus contract or an incentive contract that incorporated a fine that was enforced by a third party. Theory and experiments are complements in evaluating contract design to each other and to the sparse information from the field. Together, they look inside the legal terms of a contract, examine the interplay of its incentives with fairness considerations, and evaluate its effects on the parties.

Keywords: formal contracts, trust, contract design, incentive, negotiation, firms

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