Multitask Principal–Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design
TL;DR: In this article, a principal-agent model that can explain why employment is sometimes superior to independent contracting even when there are no productive advantages to specific physical or human capital and no financial market imperfections to limit the agent's borrowings is presented.
Abstract: Introduction In the standard economic treatment of the principal–agent problem, compensation systems serve the dual function of allocating risks and rewarding productive work. A tension between these two functions arises when the agent is risk averse, for providing the agent with effective work incentives often forces him to bear unwanted risk. Existing formal models that have analyzed this tension, however, have produced only limited results. It remains a puzzle for this theory that employment contracts so often specify fixed wages and more generally that incentives within firms appear to be so muted, especially compared to those of the market. Also, the models have remained too intractable to effectively address broader organizational issues such as asset ownership, job design, and allocation of authority. In this article, we will analyze a principal–agent model that (i) can account for paying fixed wages even when good, objective output measures are available and agents are highly responsive to incentive pay; (ii) can make recommendations and predictions about ownership patterns even when contracts can take full account of all observable variables and court enforcement is perfect; (iii) can explain why employment is sometimes superior to independent contracting even when there are no productive advantages to specific physical or human capital and no financial market imperfections to limit the agent's borrowings; (iv) can explain bureaucratic constraints; and (v) can shed light on how tasks get allocated to different jobs.
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TL;DR: In this paper, the authors examine the progressive development of the new institutional economics over the past quarter century, distinguishing four levels of social analysis, with special emphasis on the institutional environment and the institutions of governance.
Abstract: This paper examines the progressive development of the new institutional economics over the past quarter century. It begins by distinguishing four levels of social analysis, with special emphasis on the institutional environment and the institutions of governance. It then turns to some of the good ideas out of which the NIE works: the description of human actors, feasibility, firms as governance structures, and operationalization. Applications, including privatization, are briefly discussed. Its empirical successes, public policy applications, and other accomplishments notwithstanding, there is a vast amount of unfinished business.
5,184 citations
Cites background from "Multitask Principal–Agent Analyses:..."
...To focus entirely on ex ante incentive alignment, however, is a truncated way to study organization—especially if all complex contracts are unavoidably incomplete and if adaptation is the central problem of economic organization (Chester Barnard 1938; Friedrich Hayek 1945)....
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...See especially Holmstrom (1989) and Holmstrom and Milgrom (1991, 1994), where the benefits of low-powered incentives in firms are featured. buyers, are similar but different....
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...So too has been research on organization theory, especially at Carnegie (some of it prefigured by earlier work by Chester Barnard)—where the names of Richard Cyert and James March join that of Simon....
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TL;DR: In this article, a review of existing work on the provision of incentives for workers is presented, and the authors evaluate this literature in the light of a growing empirical literature on compensation from two perspectives: first, an underlying assumption of this literature is that individuals respond to contracts that reward performance.
Abstract: I NCENTIVES ARE the essence of economics. Despite many wide-ranging claims about their supposed importance, there has been little empirical assessment of incentive provision for workers. The purpose of this paper is to critically overview existing work on the provision of incentives. Since the interests of workers and their employers are not always aligned, a large theoretical literature has emphasized how firms design compensation contracts to induce employees to operate in the firm's interest. This literature has reached into many areas of compensation and has pointed to a multitude of different mechanisms that can be used to induce workers to act in the interests of their employers. These include piece rates, options, discretionary bonuses, promotions, profit sharing, efficiency wages, deferred compensation, and so on. My objective here is to evaluate this literature in the light of a growing empirical literature on compensation. Where possible, I will address the literature from two perspectives. First, an underlying assumption of this literature is that individuals respond to contracts that reward performance. Accordingly, I consider whether agents behave in this way, and whether these responses are always in the firm's interest. Second, I address whether firms write contracts with these responses in mind. In other words, do contracts look like the predictions of the theory? Incentives are provided to workers
3,455 citations
Cites background from "Multitask Principal–Agent Analyses:..."
...See Holmstrom and Milgrom (1990) and Hideshi Itoh (1992, 1993) for other work on efficient side-trades. subjectivity....
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Posted Content•
01 Jan 2012
TL;DR: The 2008 crash has left all the established economic doctrines - equilibrium models, real business cycles, disequilibria models - in disarray as discussed by the authors, and a good viewpoint to take bearings anew lies in comparing the post-Great Depression institutions with those emerging from Thatcher and Reagan's economic policies: deregulation, exogenous vs. endoge- nous money, shadow banking vs. Volcker's Rule.
Abstract: The 2008 crash has left all the established economic doctrines - equilibrium models, real business cycles, disequilibria models - in disarray. Part of the problem is due to Smith’s "veil of ignorance": individuals unknowingly pursue society’s interest and, as a result, have no clue as to the macroeconomic effects of their actions: witness the Keynes and Leontief multipliers, the concept of value added, fiat money, Engel’s law and technical progress, to name but a few of the macrofoundations of microeconomics. A good viewpoint to take bearings anew lies in comparing the post-Great Depression institutions with those emerging from Thatcher and Reagan’s economic policies: deregulation, exogenous vs. endoge- nous money, shadow banking vs. Volcker’s Rule. Very simply, the banks, whose lending determined deposits after Roosevelt, and were a public service became private enterprises whose deposits determine lending. These underlay the great moderation preceding 2006, and the subsequent crash.
3,447 citations
TL;DR: The authors show that performance incentives offered by an informed principal can adversely affect an agent's perception of the task, or of his own abilities, and also study the effects of empowerment, help and excuses on motivation, as well as situations of ego bashing reflecting a battle for dominance within a relationship.
Abstract: A central tenet of economics is that individuals respond to incentives. For psychologists and sociologists, in contrast, rewards and punishments are often counterproductive, because they undermine "intrinsic motivation". We reconcile these two views, showing how performance incentives offered by an informed principal (manager, teacher, parent) can adversely impact an agent's (worker, child) perception of the task, or of his own abilities. Incentives are then only weak reinforcers in the short run, and negative reinforcers in the long run. We also study the effects of empowerment, help and excuses on motivation, as well as situations of ego bashing reflecting a battle for dominance within a relationship.
3,060 citations
TL;DR: The authors discusses the economic implications of reciprocity and shows that a substantial fraction of people behave according to this dictum: people repay gifts and take revenge even in interactions with complete strangers and even if it is costly for them and yields neither present nor future material rewards.
Abstract: This article discusses the economic implications of reciprocity. A long-standing tradition in economics views human beings as exclusively self-interested. In most economic accounts of individual behavior and aggregate social phenomena, the vast forces of greed are put at the center of the explanation. However, many people deviate from purely self-interested behavior in a reciprocal manner. Reciprocity means that in response to friendly actions, people are frequently much nicer and much more cooperative than predicted by the self-interest model; conversely, in response to hostile actions they are frequently much more nasty and even brutal. There is considerable evidence that a substantial fraction of people behave according to this dictum: People repay gifts and take revenge even in interactions with complete strangers and even if it is costly for them and yields neither present nor future material rewards. This notion of reciprocity is thus very different from kind or hostile responses in repeated interactions that are solely motivated by future material gains.
2,516 citations
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TL;DR: In this paper, it is shown that a definition of a firm may be obtained which is not only realistic in that it corresponds to what is meant by a firm in the real world, but is tractable by two of the most powerful instruments of economic analysis developed by Marshall, the idea of the margin and that of substitution.
Abstract: Economic theory has suffered in the past from a failure to state clearly its assumptions. Economists in building up a theory have often omitted to examine the foundations on which it was erected. This examination is, however, essential not only to prevent the misunderstanding and needless controversy which arise from a lack of knowledge of the assumptions on which a theory is based, but also because of the extreme importance for economics of good judgement in choosing between rival sets of assumptions. For instance, it is suggested that the use of the word “firm” in economics may be different from the use of the term by the “plain man.”1 Since there is apparently a trend in economic theory towards starting analysis with the individual firm and not with the industry,2 it is all the more necessary not only that a clear definition of the word “firm” should be given but that its difference from a firm in the “real world,” if it exists, should be made clear. Mrs. Robinson has said that “the two questions to be asked of a set of assumptions in economics are: Are they tractable? and: Do they correspond with the real world?”3 Though, as Mrs. Robinson points out, “more often one set will be manageable and the other realistic,” yet there may well be branches of theory where assumptions may be both manageable and realistic. It is hoped to show in the following paper that a definition of a firm may be obtained which is not only realistic in that it corresponds to what is meant by a firm in the real world, but is tractable by two of the most powerful instruments of economic analysis developed by Marshall, the idea of the margin and that of substitution, together giving the idea of substitution at the margin.
21,195 citations
TL;DR: The Economic Institutions of Capitalism as mentioned in this paper is a seminal work in the field of economic institutions of capitalism. Journal of Economic Issues: Vol. 21, No. 1, pp. 528-530.
Abstract: (1987). The Economic Institutions of Capitalism. Journal of Economic Issues: Vol. 21, No. 1, pp. 528-530.
16,767 citations
8,910 citations
TL;DR: In this paper, a theory of costly contracts is presented, which emphasizes the contractual rights can by of two types: specific rights and residual rights, and when it is costly to list all specific rights over assets, it may be optimal to let one party purchase all residual rights.
Abstract: Our theory of costly contracts emphasizes the contractual rights can by of two types: specific rights and residual rights. When it is costly to list all specific rights over assets in the contract, it may be optimal to let one party purchase all residual rights. Ownership is the purchase of these residual rights. When residual rights are purchased by one party, they are lost by a second party, and this inevitably creates distortions. Firm 1 purchases firm 2 when firm 1's control increases the productivity of its management more than the loss of control decreases the productivity of firm 2's management.
8,850 citations
Posted Content•
TL;DR: In this paper, the authors present a set of reprint articles for which IEEE does not hold copyright. Full text is not available on IEEE Xplore for these articles, but full text can be found on the Internet Archive.
Abstract: This publication contains reprint articles for which IEEE does not hold copyright. Full text is not available on IEEE Xplore for these articles.
8,513 citations