Reference Points and Contractual Choices: An Experimental Examination

Authors

  • Yuval Feldman,

  • Amos Schurr,

  • Doron Teichman


  • For helpful comments we thank Oren Bar-Gill, Zev Eigen, Ido Erev, David Hoffman Yaakov Kareev, Ilana Ritov, Judith Avrahami, Tess Wilkinson-Ryan, and participants of workshops at Ben Gurion University, Bonn University, Boston University, the Hebrew University, Tel-Aviv University, the annual meeting of the American Law and Economics Association, and the conference on behavioral and experimental legal studies organized by Notre Dame Law School and the Haifa University Faculty of Law. For valuable research assistance we thank Troy Schuller. Finally, we thank the three anonymous referees and Jeff Rachlinski who all greatly improved the quality of this article. Financial support for this study was provided by the Israel Science Foundation (grant 1283/11).

Address correspondence to Doron Teichman, The Faculty of Law, The Hebrew University of Jerusalem, Mt. Scopus, Jerusalem 91905, Israel; email: doron.teichman@mail.huji.ac.il.

Abstract

This article focuses on the influence of framing on the way people understand their contractual obligations. A large body of both psychological and economic studies suggests that people treat payoffs framed as gains and payoffs framed as losses distinctly. Building on these studies, we hypothesize that the ways parties understand their duties are affected by the way in which they are framed. More specifically, we expect that promisors will tend to adopt a more self-serving interpretation when they are making decisions in the domain of losses. To test this prediction, we run a series of four experiments that are all based on a between-subject design. The first two studies utilize experimental surveys that measure and compare participants' attitudes toward a contract interpretation dilemma. The third and fourth studies are incentive-compatible experiments, in which participants' actual interpretive decisions determine their payoff. All four experiments confirm our basic hypothesis and show that framing contractual payoffs as losses rather than as gains raises parties' tendency to interpret their obligations selfishly. These findings refine some of the previous understanding regarding the ability of penalties to optimize parties' contractual behavior, especially in situations in which monitoring is limited. Based on these findings, the article revisits some of the basic questions of contract law, shedding new light on an array of issues such as the law of liquidated damages and the optimal design of contracts.

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