Relational Contracts and Inequity Aversion

Jenny Kragl & Julia Schmid
We study the effects of envy on the feasibility of relational contracts in a standard moral hazard setup with two agents. Performance is evaluated via an observable, but non-contractible signal which reflects the agent´s individual contribution to firm value. Both agents exhibit disadvantageous inequity aversion. In contrast to the literature, we find that inequity aversion may be beneficial: In the presence of envy, for a certain range of interest rates relational contracts may be more...
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