Promises & Partnership

Abstract

We examine, experimentally and theoretically, how communication within a partnership may mitigate the problem (highlighted in contract theory) of hidden action. What is the form and content of the communication? Which model of decision-making can capture the impact of communication? We consider free-form communication, measure beliefs (about actions and beliefs), and examine which motivational forces influence subjects. We find they harbor belief-dependent preferences that can be captured using psychological game theory. In particular, agents are influenced by guilt aversion, which suggests a theory of why and how communication influences behavior in which statements of intent and resulting expectations play a special role. This has bearing on how to understand partnerships and contracts.Promises; partnership; contract theory; behavioral economics; hidden action; moral hazard; lies; social preferences; psychological game theory; guilt aversion; reciprocity; fairness