Design a Contract: A Simple Principal-Agent Problem as a Classroom Experiment

Abstract

The authors present a simple classroom experiment that can be used as a teaching device to introduce important concepts of organizational economics and incentive contracting. First, students take the role of a principal and design a contract that consists of a fixed payment and an incentive component. Second, students take the role of agents and decide on an effort level. The experiment illustrates shirking opportunities of the agent and the importance of work incentives. Furthermore, it can be used to introduce students to the concepts of contractual incompleteness, efficiency, incentive compatibility, outside options and participation constraints, the Coase theorem, and the potential roles of fairness and reciprocity in contracting.

Keywords:

• classroom experiments
• Coase theorem
• efficiency
• incentive contracts
• shirking