Overconfidence and Contract Framing

Abstract

ABSTRACT Prior contract framing research finds that agents generally choose to provide greater effort under penalty contracts than under economically equivalent bonus contracts. At the same time, many individuals tend to be overconfident in their own abilities, which may alter agents’ expectancies when making effort provision decisions. In this study, we extend the contract framing literature by conducting an experiment in which participants can improve the likelihood of earning a bonus or avoiding a penalty by providing greater costly effort and by performing well on the experimental task. We find that participants who are not overconfident in their ability to perform the task well exhibit the general contract framing effect, whereas overconfident participants do not. This suggests that for work tasks where production is a function of both effort and ability, the preponderance of overconfident individuals consistent with the “better-than-average effect” mutes the effect of contract framing on effort. Data Availability: Contact the authors. JEL Classifications: M49; M12; M11.