The Economics of Agency.

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The Economics of Agency.

01 Oct 1984-

TL;DR: In this article, the authors discuss the two types of hidden action and hidden information in the principal-agent relationship and evaluate the effect of these two types on the welfare of both the principal and the agent.

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Abstract: : The agency relationship is a pervasive fact of economic life. Even in the limited sense in which the concept has traditionally been understood in ordinary and in legal discourse, the principal-agent relation is a phenomenon of significant scope and economic magnitude. But economic theory has recently recognized that analogous interactions are virtually universal in the economy, at least as one significant component of almost all transactions. The common element is the presence of two individuals. One (the agent) must choose an action from a number of alternative possibilities. The action affects the welfare of both the agent and another person, the principal. In this study of organizational efficiency this report discusses the following topics: (1) The Two Types--Hidden Action and Hidden Information;(2) Example--Public Utility Rate Setting; (3) Multiple Principles; (4) The Hidden-Action Model; (5) Monitoring; (6) Multiple Agents and Repeated Relations; (7) An Evaluation of Agency Theory.

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Journal Article•DOI•

Aggregation and linearity in the provision of intertemporal incentives

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Bengt Holmstrom, Paul Milgrom

01 Mar 1987-Econometrica

TL;DR: In this paper, the authors consider the problem of providing incentives over time for an agent with constant absolute risk aversion, and find that the optimal compensation scheme is a linear function of a vector of accounts which count the number of times that each of the N kinds of observable events occurs.

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Abstract: We consider the problem of providing incentives over time for an agent with constant absolute risk aversion. The optimal compensation scheme is found to be a linear function of a vector of N accounts which count the number of times that each of the N kinds of observable events occurs. The number N is independent of the number of time periods, so the accounts may entail substantial aggregation. In a continuous time version of the problem, the agent controls the drift rate of a vector of accounts that is subject to frequent, small random fluctuations. The solution is as if the problem were the static one in which the agent controls only the mean of a multivariate normal distribution and the principal is constrained to use a linear compensation rule. If the principal can observe only coarser linear aggregates, such as revenues, costs, or profits, the optimal compensation scheme is then a linear function of those aggregates. The combination of exponential utility, normal distributions, and linear compensation schemes makes computations and comparative statics easy to do, as we illustrate. We interpret our linearity results as deriving in part from the richness of the agent's strategy space, which makes it possible for the agent to undermine and exploit complicated, nonlinear functions of the accounting aggregates.

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2,843 citations

Journal Article•DOI•

The Social Control of Impersonal Trust

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Susan P. Shapiro

01 Nov 1987-American Journal of Sociology

TL;DR: The authors explores the sources and consequences of the paradox that the guardians of trust are themselves trustees, and discovers that the resulting collection of procedural norms, structural constraints, entry restrictions, policing mechanisms, social-control specialists, and insurance-like arrangements increases the opportunities for abuse while it encourages less acceptable trustee performance.

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Abstract: How do societies control trust relationships that are not embedded in structures of personal relations? This paper discusses the guardians of impersonal trust and discovers that, in the quest for agent fidelity, they create new problems. The resulting collection of procedural norms, structural constraints, entry restrictions, policing mechanisms, social-control specialists, and insurance-like arrangements increases the opportunities for abuse while it encourages less acceptable trustee performance. Moreover, this system sometimes leads people to throw good "money" after bad; they protect trust and respond to its failures by conferring even more trust. The paper explores the sources and consequences of the paradox that the guardians of trust are themselves trustees.

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1,694 citations

Cites background from "The Economics of Agency."

...Agents create and disseminate information that cannot be verified by its recipients because of their lack of expertise or access to data sources (Arrow 1985, pp. 38-39)....
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Journal Article•DOI•

Explaining the Limited Effectiveness of Legalistic “Remedies” for Trust/Distrust

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Sim B. Sitkin, Nancy L. Roth

01 Aug 1993-Organization Science

TL;DR: In this article, a theory that distinguishes two dimensions of trust, task-specific reliability and value congruence, is presented, and it is shown that legalistic mechanisms respond only to reliability concerns, while ignoring value-related concerns.

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Abstract: Organizations frequently adopt formal rules, contracts, or other legalistic mechanisms when interpersonal trust is lacking. But recent research has shown such legalistic “remedies” for trust-related problems to be ineffective in restoring trust. To explain this apparent ineffectiveness, this paper outlines a theory that distinguishes two dimensions of trust—task-specific reliability and value congruence—and shows how legalistic mechanisms respond only to reliability concerns, while ignoring value-related concerns. Organizational responses to employees with HIV/AIDS are used as a case illustration that supports the theory's major propositions. The paper concludes with an agenda for future research.

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1,513 citations

Book Chapter•DOI•

The theory of contracts

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Oliver Hart, Bengt Holmstrom

01 Mar 1986-Research Papers in Economics

TL;DR: The authors presented at the World Congress of the Econometric Society, Cambridge, Massachusetts, 1985, The authors, a paper that was later used at the International Journal of Mathematical Information.

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Abstract: This paper was presented at the World Congress of the Econometric Society, Cambridge, Massachusetts, 1985

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1,454 citations

Cites background or methods from "The Economics of Agency."

...This "hidden information" assumption, as Kenneth Arrow has termed it, has force when the party with private information is risk-averse.(25) It is this supposition that underlies the models of Azariadis (1983) and Grossman and Hart (1981, 1983b): The firm is identified with its risk-averse manager....
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...That is, there has been a move away from the impersonal Arrow-Debreu market setting where people make trades "with the market," to a situation where firm A and firm B, or firm C and union D, write a long-term contract. This departure is not without economic significance. Williamson (1985), in particular, has stressed the importance of situations where a small number of parties make investments which are to some extent relationship-specific; that is, once made, they have a much higher value inside the relationship than outside....
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...Arrow (1985) has recently suggested the informative names Hidden Action Model and Hidden Information Model for these two subcategories....
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...In the latter case, it is unclear how reputation can overcome the asymmetry of information between the parties that is the reason for the departure from an Arrow-Debreu contract. The role of reputation in sustaining a contract can be illustrated using the following model [based on Bull (1985) and Kreps (1984); this is an even simpler model of incomplete contracts than that of the last section]. Assume that a buyer B and a seller S wish to trade an item at date 1 that has value v to the buyer and cost c to the seller, where v > c. There are no ex ante investments and the good is homogeneous, so quality is not an issue. Suppose, however, that it is not verifiable whether trade actually occurs. Then a legally binding contract which specifies that the seller must deliver the item and the buyer must pay /?, where v>p>c, cannot be enforced. The reason is - assuming (as we shall) that simultaneous delivery and payment are infeasible - that if the seller has to deliver first then the buyer can always deny that delivery occurred and refuse payment, while if the buyer has to pay first, the seller can always claim later that he did deliver even when he did not. As a result, if the parties must rely on the courts, a gainful trading opportunity will be missed. The idea that not even the level of trade is verifiable is extreme, and Bull (1985) in fact makes the more defensible assumption that it is the quality of the good that cannot be verified (in Bull's model, S is a worker and quality refers to his performance)....
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...In the latter case, it is unclear how reputation can overcome the asymmetry of information between the parties that is the reason for the departure from an Arrow-Debreu contract. The role of reputation in sustaining a contract can be illustrated using the following model [based on Bull (1985) and Kreps (1984); this is an even simpler model of incomplete contracts than that of the last section]....
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Journal Article•DOI•

Boundary Organizations in Environmental Policy and Science: An Introduction

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David H. Guston¹•Institutions (1)

Rutgers University¹

01 Oct 2001-Science, Technology, & Human Values

TL;DR: For example, the authors argues that the blurring of boundaries between science and politics, rather than the intentional separation often advocated and practiced, can lead to more productive policy-making.

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Abstract: Scholarship in the social studies of science has argued convincingly that what demarcates science from nonscience is not some set of essential or transcendent characteristics or methods but rather an array of contingent circumstances and strategic behavior known as "boundary work" (Gieryn 1995, 1999). Although initially formulated to explain how scientists maintain the boundaries of their community against threats to its cognitive authority from within (e.g., fraud and pseudo-science), boundary work has found useful, policy-relevant applications-for example, in studying the strategic demarcation between political and scientific tasks in the advisory relationship between scientists and regulatory agencies (Jasanoff 1990). This work finds that the blurring of boundaries between science and politics, rather than the intentional separation often advocated and practiced, can lead to more productive policy making. If it is the case, however, that the robustness of scientific concepts such as causation and representation are important components of liberal-democratic thought and practice (Ezrahi 1990), one can imagine how the flexibility of boundary work might lead to confusion or even dangerous instabilities between science and nonscience. These risks could be conceived, perhaps, as the politicization of science or the reciprocal scientification of politics. Neither risk should here be understood to mean the importation to one enterprise from the other elements that are entirely foreign; that is, science is not devoid of values prior to some politicization, nor politics of rationality, prior to any scientification. Rather, both should be understood to mean the rendering of norms and practices in one enterprise in a way that unreflexively mimics norms and practices in the other. These concerns have been central to the socalled science wars, and to the extent that they are implicated in public discussions of such policy issues as health and safety regulation, climate change, or genetically modified organisms, they are real problems for policy makers and publics alike.'

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1,287 citations

Cites background or result from "The Economics of Agency."

...The success of the organization in performing these tasks can then be taken as the stability of the boundary, while in practice the boundary continues to be negotiated at the lowest level and the greatest nuance within the confines of the organization.3 This dual agency makes the boundary organization a site of what Sheila Jasanoff (1996, 397), following Bruno Latour, has labeled “coproduction,” the simultaneous production of knowledge and social order....
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...cal School-and the Global Environmental Assessment project-a collaborative, interdisciplinary effort based at Harvard University to improve the linkage between science and policy in society's efforts to deal with problems of global environmental change. For the workshop report, see Guston et al. (2000). 7....
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...This function is akin to the "boundary-ordering devices" of Shackley and Wynne ( 1996, 293), which "produce a consistency of effect, even though the precise position of the boundary between science and policy is not consistent." 4. The idea of spanning is also explicit in the bridging institutions described by Powers (1991), although the balancing was only implicit and the role of boundary objects and/or stan-...
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...3 This dual agency makes the boundary organization a site of what Sheila Jasanoff (1996, 397), following Bruno Latour, has labeled "coproduction," the simultaneous production of knowledge and social order. Boundary organizations are involved in coproduction in two ways: they facilitate collaboration between scientists and nonscientists, and they create the combined scientific and social order through the generation of boundary objects and standardized packages. The concept of the boundary organization differs in subtle but important ways from German political scientist Dietmar Braun's (1993) description of intermediary agencies....
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The Economics of Agency.

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