19 November 2017
We examine the behavior of subjects in a simple principal-agent game with hidden action. While subjects in the role of agents tend to choose the actions which maximize their expected profits, subjects in the role of principals offer contracts which differ from the theoretical predictions. We identify three principles of contract design: (1) the agent’s remuneration for the better outcome is at least as high as the remuneration for the worse outcome. (2) The agent must not risk making a loss. (3) The net profit of the agent should not be higher than the net profit of the principal. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: C91; D82.