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So far the classical contract theory has never given a reasonable explanation to why most incentive contracts in reality are linear, although it has been applied to many economic domains widely in recent years. By incorporating inequity aversion into the standard frame of designing optimal contract, which is an important preference investigated by game experiments and behavioral economics while ignored by the classical contract theory, this paper shows that the optimal contract under inequity aversion is linear definitely, and the slope increases with the strength of inequity aversion within the limit 0.5, which is consistent with the result of positive findings. Therefore, incorporating inequity aversion surely provides a rational explanation to the linearity of incentive contract from the approach of behavioral contract theory.
Date of Conference: 20-22 Sept. 2009