Payment Contract Design With Application Under Fairness Preference

As the theoretic tools of researching the incentive mechanism under condition of asymmetric information, game theory and contract theory have been widely and deeply applying to design payment contract, especially that for enterprise operator, which accelerate the reform and development of enterprise and economy.However, in recent years there emerge three new problems as follows. First, the positive test of contract econometrics finds that contract theory did not explain economic phenomena well and did not forecast economic behaviors either in many important fields. Second, Ultimatum Game experiment and other game experiments have proved that there is fairness preference, which is inconsistent with the self-interest hypothesis of contract theory. Third, the theoretic analysis and positive study in the science of organizational behavior figure out that fairness and justice is one of the most important factors influencing personnel incentives. It is because contract theory ignores fairness preference that the payment contact designed by classical contract theory can't explain practice very well. Therefore, it is necessary to introduce fairness preference into the standard frame of contract design in order to enhance the power to direct practice. This paper will try to do the related theoretic research.Firstly, as the base of theoretic analysis, this paper reviews and sums up the research on fairness preference in economics.The related literatures can be classified into three fields, which include the game experiments revealing fairness preference, the theoretic models describing fairness preference and the game experiments testing the theoretic models. The FS model is accepted and applied widely because it trades off authenticity of hypothesis and tractability of model very well, and it can explain and predict the results of all game experiments. Hence, this paper is based on FS model too.Secondly, as the expansion of contact theory, this paper investigates the payment contract for a single agent based on fairness preference.Theoretical research indicates that the optimal payment contract for a single agent under fairness preference must be linear, the slope of which increases with fairness preference within the upper limit of 0.5. This is the reasons why most real payment contracts are linear, which contract theory hasn't explain well. Under fairness preference, any variables that can affect the allocation of payment between principal and agent, although they may do not inflect any information of agent's effort, should be designed in the optimal contract, which is over determinate. And any variables that may restrict or even prevent the chances of principal and agent to signal their behavioral motivations, although they may actually inflect information of agent's effort, should not be designed in the optimal contract, which is incomplete. This is the reason why some real payment contracts are over determinate or incomplete.Thirdly, as another expansion of contact theory, this paper investigates the payment contract for multiple agents under fairness preference.Theoretical analysis shows that the optimal payment contract for multiple agents under fairness preference must be the joint contract that is based on both the individual output and the joint output, instead of the independent contract that is based only on the individual output, by which the Sufficient Statistical Result of contract theory does not work any more. With the hypothesis of risk neutral, the joint contract may be the contract of extreme team performance evaluation, the contract of extreme relative performance evaluation and the middle contract of joint performance evaluation. And the fairness preference will enhance incentive efficiency because both the more payment and the fairer payment can provide incentives. While with the hypothesis of risk aversion, the joint contract may be the team contract of relativism that is optimal under weaker fairness preference, and the team contract of egalitarian that is optimal under stronger or even very strong fairness preference. And the fairness preference will result in incentive efficiency losses because the principal has to compensate not only the risk premium of information stemming from asymmetric information, but also the risk premium of fairness stemming from both fairness preference and asymmetric information. Generally, the fairness preference is both an incentive constraint and an incentive instrument, and so to adjust the allocation of payment according to the strength of the fairness preference right can improve the incentive efficiency, while too fair or too unfair allocation both will lead to incentive efficiency losses.Lastly, as the application of the optimal payment contract for multiple agents, under fairness preference, this paper researches the incentive mechanisms for rank order tournament and team production.On one hand, the fairness preference will reduce the incentive efficiency of rank order contest and improve the precision of performance evaluation, while the preference of status seeking can increase the efforts of agents and the expected profits of principal. So, rank order contest should not be applied to agents with fairness preference but to those of status seeking. This conclusion can explain why the vertical promotion coexists with lateral promotion in reality widely.On the other hand, strong enough peer pressures and behavioral norm by which each anticipates that many enough peers will cooperate are the two requirements to realize team cooperation. The internal pressures stem from the fairness preference, while the external pressures result from peer sanction only via fairness preference. Only when the fairness preference is very strong, can the internal pressures realize team cooperation. And the external pressures can realize team cooperation when the sanction cost is not too high and the fairness preference is not too weak. But only with the behavioral norm by which each anticipates that many enough peers will cooperate, can implement uniquely team cooperation both the internal and the external peer pressures. Then, there should be two ways to cultivate team spirit. One way is to foster fairness preference, which can bring up strong peer pressures. The other way is to improve the beliefs on the possibility of cooperation, which means that quite a few peers like to cooperate with others.All the above researches expand the hypothesis of classical contract theory, which has made important progress as follows.Theoretically, this paper designs the optimal payment contract in the case of a single agent and the case of multiple agents respectively, and the incentive mechanisms for rank order tournament and team cooperation, based on the more rational hypothesis of fairness preference, by introducing the fairness preference into the standard frame of game analysis and principal-agent theory. It will modify and expand the research conclusions of classical contract theory, and hence can enrich and promote the development of behavioral contract theory to form the its own theoretic system. Furthermore, it integrates the different hypothesis and different paradigm of organizational behaviors and contract theory, which will accelerate the development of personnel economics and facilitate the study of more general organizational behaviors by the economic methodology of game theory and contract theory.Practically, the research conclusions based on the fairness preference can explain some economic phenomena that classical contract theory can't explain or even contradicts with the prediction of classical contract theory, including linearity and low incentive intensity of payment contract, incompleteness and over-determinateness of payment contract, offering stock option to lower employees and coexisting of vertical promotion and lateral promotion, etc, which can offer scientific instructions for enterprises'reform and economic development in the transitional economy and micro incentive mechanism for building harmonious society.Moreover, this paper will possibly turn on some new research methods and fields. For example, the future works can try to synthesize the research methods of psychology such as personality evaluation, and methods of economics such as designing incentive mechanism for adverse selection, to evaluate and screen the strength of fairness preference, and try to synthesize further the different hypothesis and different paradigm of organizational behaviors and contract theory by integrating procedural justice, interpersonal justice and informational justice into reciprocity, by which more general organizational behavior can be studied by the economic methodology of game theory and contract theory.