This paper studies the question of how to overcome inefficiencies due to hidden actions in a rational milieu, such as a grid computing system with open clientele. We consider the so-called principal-agent model known from economic theory, where the members (or agents) of a distributed system collaborate in complex ways. We adopt the perspective of the principal and investigate auditing mechanisms that incentivize participants to contribute more to a common project. The paper analyzes the tradeoff between auditing costs and the scarce effort exerted by the participants, and presents optimal solutions for this optimization problem in different scenarios. 1

We report on several experiments on the optimal allocation of ownership rights. The experiments confirm the property rights approach by showing that the ownership structure affects relationshipspecific investments and that subjects attain the most efficient ownership allocation despite starting from different initial conditions. However, in contrast to the property rights approach, the most efficient ownership structure is joint ownership. These results cannot be explained by the self-interest model nor by models that assume that all people behave fairly but they are largely consistent with approaches that focus on the interaction between selfish and fair players. Small firms in service industries such as law, consulting, accounting, advertising and medicine are often organised as partnerships. In these firms relationship specific investments seem to be important and particularly difficult to contract upon. We often observe that these firms are governed by a very simple governance structure: the partners jointly own the assets of the firm and share profits. This observation is inconsistent with the modern property rights approach pioneered by Grossman and Hart (1986) and Hart and Moore (1990) who argue that joint ownership is rarely optimal: 1 if two parties jointly own an asset they can prevent each other from using it,

We examine how social preferences affect behavior and surplus in relational contracts. Experimental subjects participate in a contracting environment similar to Brown, Falk, and Fehr [Brown, M., Falk, A. & Fehr, E., "Relational Contracts and the Nature of Market Interactions, Econometrica, 72 (2004):747-780] and in social preference experiments adapted from Charness and Rabin [Charness, G. & Rabin, M. "Understanding Social Preferences with Simple Tests." The Quarterly Journal of Economics 117(2002): 817-869]. Subjects' behavior during the Charness and Rabin experiment is a significant predictor of behavior and outcomes observed during the subsequent multi-period, finite-horizon, relational-contracting environment, which features market power, unenforceable performance, reputation formation and endogenous matching of trading partners. Compared to subjects who respond to the Charness-Rabin games in a fashion consistent with purely self-interested, competitive or reciprocal social preferences, buyers and sellers with alternative social preference structures engage in contracts with substantially higher quality and price, which leads to greater surplus for both parties. A key difference is that self-interested, competitive and reciprocal buyers respond to early-period shirking by extending subsequent offers that are less generous to the seller, while buyers with other social preferences extend subsequent offers that are more generous. Reciprocal and competitive sellers and, to a lesser extent, self-interested sellers, deliver sub-contractual levels of quality more often, which substantially lowers buyer and total welfare. We conclude that intentional or `cold' measures of social preferences have considerable predictive power in dynamic, interactive (or `hot') economic set...

This paper combines a randomized experiment and a structural model to test whether monitoring and financial incentives can reduce teacher absence and increase learning. In 57 schools in India, randomly chosen out of 113, a teacher’s daily attendance was verified through photographs with time and date stamps, and his salary was made a non-linear function of his attendance. The teacher absence rate changed from 42 percent in the comparison schools to 21 percent in the treatment schools. To separate the effects of the monitoring and the financial incentives, we estimate a structural dynamic labor supply model that allows for heterogeneity in preferences and auto-correlation of external shocks. The teacher response was almost entirely due to the financial incentives. The estimated elasticity of labor with respect to the incentive is 0.306. Our model accurately predicts teacher attendance in two out-of-sample tests on the comparison group and a treatment group that received different financial incentives. The program improved child learning: test scores in the treatment schools were 0.17 standard deviations higher than in the comparison schools. This project is a collaborative exercise involving many people. Foremost, we are deeply indebted to Seva Mandir, and especially to Neelima Khetan and Priyanka Singh, who made this evaluation possible. We thank Ritwik Sakar

ABSTRACT: In this paper we reply to Binmore and Shaked’s criticism of the Fehr-Schmidt model of inequity aversion. We put the theory and their arguments into perspective and show that their criticism is not substantiated. Finally, we briefly comment on the main challenges for future research on social preferences.

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When contracting is not possible, a preference for fair exchange can generate efficient exchange, fully exhausting the potential gains from trade — or no exchange at all, leaving all gains from trade unexploited. A profit-maximizing firm offers a wage to a fair-minded worker, who then chooses how much effort to exert. The Rotten Firm theorem says: if the worker cares sufficiently about fairness and the firm employs the worker, the equilibrium transaction is Pareto efficient. However, even when gains from trade were possible, the firm may not to hire the worker because every “fair ” transaction (acceptable to the worker) could be less profitable than the firm’s outside option. The theory explains a puzzle: why firms offer profit-sharing plans to