Trust and Incentives in Principal-Agent Negotiations

Gary J. Miller and Andrew B. Whitford
Additional contact information
Gary J. Miller: Washington University in St Louis, gjmiller@artsci.wustl.edu
Andrew B. Whitford: University of Kansasm whitford@ku.edu

Journal of Theoretical Politics, 2002, vol. 14, issue 2, 231-267

Abstract: The canonical principal-agent problem involves a risk-neutral principal who must use incentives to motivate a risk-averse agent to take a costly, unobservable action that improves the principal’s payoff. The standard solution requires an inefficient shifting of risk to the agent. This article, however, summarizes experimental research that throws doubt on the validity of this conclusion. Experimental subjects were routinely able to achieve efficiency in agent effort levels without inefficient risk-sharing. These experimental outcomes, while anomalous from the standpoint of principal-agency theory, are quite consistent with other experimental data testing notions of trust-based implicit contracting. Such contracting within a hierarchy may allow an outcome preferred, by both principal and agent, to that deemed possible by principal-agency theory. If this is true, then the lessons to be learned from principal-agency theory are all the wrong ones. Concentrating on incentives can crowd out the very qualities in a relationship that make social efficiency possible.

Keywords: agency; contracts; incentives; risk; trust (search for similar items in EconPapers)
Date: 2002
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:jothpo:v:14:y:2002:i:2:p:231-267

DOI: 10.1177/095169280201400204

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