Incorporating Reciprocity into Contracts as Reference Points

Reciprocity is intuitively essential to almost every relationship, and many experimental studies indicate that people are driven by it. In this paper, we propose a theory that a party's ex post performance is only partially dependent on whether the outcome satisfies his entitlement, and develop a model to incorporate reciprocity into reference points contracts. Our analysis shows that other than the outcome, additional factors such as shading ability should be taken into consideration, and people may fall into “reciprocity dilemma”, thus mechanisms are needed to incentivize constructive actions, we briefly propose one named “supplemental review” to address this issue