DP3017 Do Incentive Contracts Crowd Out Voluntary Cooperation?

Author(s): Ernst Fehr , Simon Gächter

Publication Date: October 2001

Keyword(s): incentive contracts , reciprocity , incomplete contracts , voluntary cooperation , experiments

JEL(s): J41

Programme Areas: Industrial Organization , Labour Economics

Link to this Page: www.cepr.org/pubs/dps/DP3017.asp

In this Paper we provide experimental evidence indicating that incentive contracts may cause a strong crowding out of voluntary cooperation. This crowding-out effect constitutes costs of incentive provision that have been largely neglected by economists. In our experiments the crowding-out effect is so strong that the incentive contracts are less efficient than contracts without any incentives. Principals, nonetheless, prefer the incentive contracts because they allow them to appropriate a much larger share of the (smaller) total surplus and are, hence, more profitable for them.