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Testing Contract Theory: a Survey of Some Recent Work

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Testing Contract Theory: a Survey of Some Recent Work TESTING CONTRACT THEORY: A SURVEY OF SOME RECENT WORK PIERRE ANDRÉ CHIAPPORI BERNARD SALANIÉ CESIFO WORKING PAPER NO. 738 CATEGORY 9: INDUSTRIAL ORGANISATION JUNE 2002 PAPER PRESENTED AT CESIFO AREA CONFERENCE ON INDUSTRIAL ORGANISATION, APRIL 2002 CESifo Working Paper No. 738 TESTING CONTRACT THEORY: A SURVEY OF SOME RECENT WORK* Abstract While the theoretical literature on contracts has been enormous since the seventies, empirical tests of the theory have long remained scarce. However, new empirical work has been developed in the last ten years that sheds light on the empirical validation of the theory. This paper aims at surveying the recent empirical work on contracts. The focus throughout is on the need to properly account for unobserved heterogeneity. JEL Classification: D8, C5. Pierre André Chiappori Bernard Salanié Department of Economics CREST - INSEE University of Chicago 15 bd Gabriel-Péri 1126 East 59th Street 92245 Malakoff Chicago, IL 60637 France U.S.A. [email protected] * We thank our discussant Patrick Legros and Jeff Campbell, Pierre Dubois, Philippe Gagnepain, Lars Hansen, Jim Heckman, Bruce Shearer, Steve Tadelis and Rob Townsend for their comments. This paper was written while Salanié was visiting the University of Chicago, which he thanks for its hospitality. Testing Contract Theory: A Survey of Some Recent Work P.A. Chiappori B. Salanié 1 Introduction It is a capital mistake to theorise before one has data. Arthur Conan Doyle, A Scandal in Bohemia. Since the early seventies, the development of the theoretical literature on contracts has been nothing short of explosive. The study of more and more sophisticated abstract models has gone hand in hand with the use of the tools of the theory to better understand many fields of economics, such as industrial organization, labor economics, taxation, insurance markets or the economics of banking. However, it is only fair to say that the empirical validation of the theory has long lagged behind the theoretical work. Many papers consist of theoretical analyses only, withlittle attention to the facts. Others state so-called stylized facts often based on fragile anecdotal evidence and go on to study a model from which these stylized facts can be derived. 1 ÍÒØiÐ Øhe b egiÒÒiÒg Óf Øhe eighØie׸ eÑÔiÖicaÐ Øe×Ø× Ù×iÒg acØÙaÐ daØa aÒd ecÓÒÓÑeØÖic ÑeØhÓ d× ÛeÖe ÚeÖÝ ÖaÖe¸ eÚeÒ ØhÓÙgh Øhe ØheÓÖeØicaÐ ÐiØeÖaØÙÖe had bÝ ØheÒ giÚeÒ biÖØh ØÓ a ÐaÖge ÒÙÑbeÖ Óf iÒØeÖe×ØiÒg Øe×ØabÐe ÔÖedicØiÓÒ׺ ÏhiÐe ×Ùch a ÐÓÒg Ðag i× ÒÓØ ÙÒØÝÔicaÐ iÒ ecÓÒÓÑic׸ iØ i× cÐeaÖÐÝ ÙÒfÓÖØÙ¹ ÒaØe¸ e×Ô eciaÐÐÝ ÛheÒ ÓÒe cÓÑÔaÖe× ÓÙÖ ÔÖacØice ØÓ ØhaØ Óf ÓØheÖ ×cieÒØi×Ø׺ EÚeÒ ÛiØhÓÙØ fÙÐÐÝ ×haÖiÒg Øhe ×ÓÑeÛhaØ eÜØÖeÑe ÑeØhÓ dÓÐÓgicaÐ ÚieÛ× eܹ ÔÖe××ed ab ÓÚe bÝ ËheÖÐÓ ck ÀÓÐÑe׸ ÓÒe caÒ haÖdÐÝ di×ÔÙØe ØhaØ iÒØeÖacØiÓÒ× beØÛeeÒ ØheÓÖÝ aÒd ÖeaÐiØÝ aÖe aØ Øhe cÓÖe Óf aÒÝ ×cieÒØi¬c aÔÔÖÓachº ÌÓ giÚe ÓÒÐÝ ÓÒe eÜaÑÔÐe¸ Øhe ÑÓ deÐ× Óf iÒ×ÙÖaÒce ÑaÖkeØ× ÙÒdeÖ a×ÝÑÑeØÖic iÒfÓÖÑaØiÓÒ deÚeÐÓÔ ed aØ Øhe b egiÒÒiÒg Óf Øhe ×eÚeÒØie× ÛeÖe ÓÒÐÝ eÜØeÒ×iÚeÐÝ Øe×Øed ´aÒd fÓÙÒd ØÓ Ðack eÑÔiÖicaÐ ×ÙÔÔ ÓÖص iÒ Øhe ÑiddÐe Óf Øhe ÒiÒeØie׺ Áf Øhi× had beeÒ dÓÒe eaÖÐieÖ¸ Øhe ØÛeÒØݹÝeaÖ ÔeÖiÓd cÓÙÐd haÚe beeÒ Ù×ed ØÓ deÚi×e b eØØeÖ ÑÓ deÐ׺ FÓÖØÙÒaØeÐݸ a ÒÙÑbeÖ Óf eÑÔiÖicaÐ Öe×eaÖcheÖ× haÚe ØÙÖÒed ØheiÖ aØØeÒ¹ ØiÓÒ ØÓ Øhe ØheÓÖÝ Óf cÓÒØÖacØ× iÒ ÖeceÒØ ÝeaÖ׸ ×Ó ØhaØ ×Ùch ÐÓÒg Ðag× ×hÓÙÐd b ecÓÑe Ðe×× cÓÑÑÓÒº Ìhi× ×ÙÖÚeÝ ÛiÐÐ ÔÖe×eÒØ a ÔaÒÓÖaÑa Óf Øhi× bÙÖgeÓÒ¹ iÒg ÐiØeÖaØÙÖeº BecaÙ×e ÒeÛ ÔaÔ eÖ× aÖe aÔÔ eaÖiÒg eÚeÖÝ Ûeek iÒ Øhi× ¬eÐd¸ Ûe caÒÒÓØ cÐaiÑ ØÓ be eÜhaÙ×ØiÚeº Ïe jÙ×Ø hÓÔ e ØhaØ Ûe caÒ cÓÒÚeÝ ØÓ Øhe ÖeadeÖ bÓØh a ×eÒ×e Óf eÜciØeÑeÒØ aØ Øhe×e ÖeceÒØ deÚeÐÓÔÑeÒØ× aÒd aÒ ÙÒ¹ deÖ×ØaÒdiÒg Óf Øhe ×Ô eci¬c ecÓÒÓÑeØÖic ÔÖÓbÐeÑ× iÒÚÓÐÚed iÒ ØakiÒg cÓÒØÖacØ ØheÓÖÝ ØÓ Øhe daØaº A ÙÒifÝiÒg ØheÑe Óf ÓÙÖ ×ÙÖÚeÝ i× Øhe Òece××iØÝ Óf cÓÒØÖÓÐÐiÒg adeÕÙaØeÐÝ fÓÖ ÙÒÓb×eÖÚed heØeÖÓgeÒeiØÝ iÒ Øhi× ÐiØeÖaØÙÖeº Áf iØ i× ÒÓØ dÓÒe ÔÖÓÔ eÖÐݸØheÒ Øhe cÓÑbiÒaØiÓÒ Óf ÙÒÓb×eÖÚed heØeÖÓgeÒeiØÝ aÒd Óf eÒdÓgeÒÓÙ× ÑaØchiÒg Óf ageÒØ× ØÓ cÓÒØÖacØ× i× b ÓÙÒd ØÓ cÖeaØe ×eÐecØiÓÒ bia×e× ÓÒ Øhe ÔaÖaÑeØeÖ× Óf iÒØeÖe×غ Ìhi× i× giÚeÒ a ×ØÖikiÒg iÐÐÙ×ØÖaØiÓÒ iÒ a ÖeceÒØcÓÒØÖibÙØiÓÒ bÝAckeÖ¹ b eÖg aÒd BÓØØiciÒi ´½999µº ÌheÝ cÓÒ×ideÖ Øhe chÓice beØÛeeÒ ×haÖecÖÓÔÔiÒg aÒd ¬Üed ÖeÒØ cÓÒØÖacØ× iÒ a ØeÒaÒعÐaÒdÐÓÖd ÖeÐaØiÓÒ×hiÔº ËØaÒdaÖd ÑÓÖaÐ haÞaÖd ÑÓ deÐ× ×ØÖe×× Øhe ØÖade¹Ó« b eØÛeeÒ iÒceÒØiÚe× aÒd Öi×k¹×haÖiÒg iÒ Øhe deØeÖÑiÒaØiÓÒ Óf cÓÒØÖacØÙaÐ fÓÖÑ׺ FiÜed ÖeÒØ cÓÒØÖacØ× aÖe ÚeÖÝ eÆcieÒØ fÖÓÑ Øhe iÒceÒØiÚe× ÚieÛÔ ÓiÒظ ×iÒce Øhe ØeÒaÒØ i× b ÓØh Øhe ÑaiÒ deci×iÓÒ ÑakeÖ aÒd Øhe Öe×idÙaÐ cÐaiÑaÒغ ÀÓÛeÚeÖ¸ ØheÝ aÐ×Ó geÒeÖaØe a ÚeÖÝ iÒ¹ eÆcieÒØ aÐÐÓ caØiÓÒ Óf Öi×k¸ iÒ Ûhich aÐÐ Øhe Öi×k i× b ÓÖÒe bÝ ÓÒe ageÒظ Øhe ØeÒaÒظ ÛhÓ i× ÔÖe×ÙÑabÐÝ ÑÓÖe Öi×k aÚeÖ×eº ÏheÒ ÙÒceÖØaiÒØÝ i× ×ÑaÐи Öi×k ×haÖiÒg ÑaØØeÖ× Ðe×׸ aÒd ¬Üed ÖeÒØ cÓÒØÖacØ× aÖe ÑÓÖe ÐikeÐÝ ØÓ b e adÓÔØedº ÇÒ Øhe cÓÒØÖaÖݸiÒaÚeÖÝ ÙÒceÖØaiÒ eÒÚiÖÓÒÑeÒظ Öi×k ×haÖiÒg i× ÔaÖaÑÓÙÒظ aÒd ×haÖecÖÓÔÔiÒg i× Øhe ÒaØÙÖaÐ cÓÒØÖacØÙaÐ fÓÖѺ Ìhi× ÔÖedicØiÓÒ caÒ Öead¹ iÐÝ be Øe×Øed fÖÓÑ daØa ÓÒ eÜi×ØiÒg cÓÒØÖacØ׸ ÔÖÓÚided ØhaØ a ÔÖÓÜÝ fÓÖ Øhe ¾ ÐeÚeÐ Óf Öi×k i× aÚaiÐabÐeº FÓÖ iÒ×ØaÒce¸ if ×ÓÑe cÖÓÔ× aÖe kÒÓÛÒ ØÓ be ÑÓÖe Öi×kÝ ØhaÒ ÓØheÖ׸ Øhe ØheÓÖÝ ÔÖedicØ× ØhaØ Øhe×e cÖÓÔ× aÖe ÑÓÖe ÐikeÐÝ ØÓ be a××Ó ciaØed ÛiØh ×haÖecÖÓÔÔiÒg cÓÒØÖacØ׺ A ÒÙÑbeÖ Óf ÔaÔ eÖ× haÚe Øe×Øed Øhi× ÔÖedicØiÓÒ bÝ ÖegÖe××iÒg cÓÒØÖacØ chÓice ÓÒ cÖÓÔ Öi×kiÒe×׺ Ìhe ÙÒdeÖÐÝiÒg aÖgÙÑeÒظ hÓÛeÚeÖ¸ ha× aÒ ÓbÚiÓÙ× ÛeakÒe××: iØ Øake× cÓÒØÖacØ× a× eÜÓgeÒÓÙ×ÐÝ giÚeÒ¸ aÒd di×ÖegaÖd× aÒÝ Ô Ó××ibÐe eÒdÓgeÒeiØÝ iÒ Øhe ÑaØchiÒg Óf ageÒØ× ØÓ cÓÒØÖacØ׺ ÁÒ ÓØheÖ ÛÓÖd׸ Øhe ØheÓÖeØicaÐ ÔÖedicØiÓÒ de×cÖib ed ab ÓÚeÓÒÐÝhÓÐd× fÓÖ giÚeÒ chaÖacØeÖi×Øic× Óf Øhe ÐaÒdÐÓÖd aÒd Øhe ageÒØ׺ ÁØ caÒ be ØakeÒ ØÓ Øhe daØa ÓÒÐÝ ØÓ Øhe eÜØeÒØ ØhaØ Øhi× \eÚeÖÝØhiÒg eÕÙaÐ" a××ÙÑÔØiÓÒ i× ×aØi׬ed¸ ×Ó ØhaØ ageÒØ× faciÒg di«eÖeÒØ cÓÒØÖacØ× dÓ ÒÓØ di«eÖ bÝ ×ÓÑe ÓØheÖÛi×e ÖeÐeÚaÒØ chaÖacØeÖi×Øicº A××ÙÑe¸ ÓÒ Øhe cÓÒØÖaÖݸ ØhaØ ageÒØ× eÜhibiØ eÜ aÒØe heØeÖÓgeÒeÓÙ× degÖee× Óf Öi×k aÚeÖ×iÓÒº ÌÓkeeÔ ØhiÒg× ×iÑÔÐe¸ a××ÙÑe ØhaØ a fÖacØiÓÒ Óf Øhe ageÒØ× aÖe Öi×k ÒeÙØÖaи ÛhiÐe Øhe Öe×Ø aÖe Öi×k aÚeÖ×eº Di«eÖeÒØageÒØ× ÛiÐÐ b e dÖaÛÒ ØÓ di«eÖeÒØ cÖÓÔ×; 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