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CRIEFF Discussion Paper Number 0902

Social welfare versus inequality aversion in an incomplete contract experiment

Marco Faravelli, Oliver Kirchkamp, Helmut Rainer

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We present the first laboratory study showing that concerns for social welfare are key determinants of investment behavior in a world of incomplete contracting. Two equally productive players simultaneously decide how much to invest into a joint production process. The total monetary benefit from joint production is split according to a sharing rule which may be symmetric or asymmetric. Standard equilibrium predictions imply inefficiently low investments and unequal payoff distributions. We show that concerns for social welfare and inequality aversion call for opposite investment choices. In the experiment, participants reveal a concern for social welfare but appear not to care about inequality. As a consequence, observed investments are larger than equilibrium investments in a selfish world. Surprisingly, even materially disadvantaged players care more for social welfare than for equality. Social welfare therefore increases but so does inequality. We also study conditions under which players give up an advantageous sharing rule. Power-sharing can be successful in the experiment, even when it is not in a selfish world.

JEL codes: C91, D23, D86
Keywords: Experiments, Incomplete Contracts, Relationship-Specific Investment, Allocation of Power, Social Preferences

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