TITLE:
Joint Contract under Inequity Aversion
AUTHORS:
Guangxing WEI, Yanhong QIN
KEYWORDS:
inequity aversion, contract design, optimal contract, principal-agent, contract theory
JOURNAL NAME:
Journal of Service Science and Management,
Vol.2 No.3,
September
10,
2009
ABSTRACT: The standard contract theory adopts the traditional hypothesis of pure self-interest. However, a series of game experiments have proven that people are not any self-interest but also inequity averse. Then, how will the inequity aversion influence the optimal contract for multiple agents? This paper attempts to obtain new theoretical insights by incorporating inequity aversion into the standard frame of optimal contract design. The optimal contract under relatively weak inequity aversion is found to be the relative joint contract, by which payment to each independent agent increases with his own output and others’ and agents with higher output will be paid more, while what under strong, even very strong, inequity aversion is the egalitarian joint contract, by which payment to each independent agent is always equal and hence agents with lower output will not be paid less. Moreover, it is shown that the inequity aversion results in incen-tive efficiency losses as agents with inequity aversion will suffer disutility in face of unfair allocation. Consequently, the principal has to pay additional inequity rent and risk compensation for inequity aversion to the agents, which both are the incentive efficiency losses resulted from inequity aversion and have never been explored by the standard contract theory, besides information rent and risk compensation for asymmetric information, which both have been probed in the standard contract theory deeply. In this way, this paper designs the optimal contracts for multiple agents with more realistic assumptions and hence can explain real economic behaviors more properly.