The Principal's Moral Hazard: Constraints on the Use of Incentives in Hierarchy

Posted: 17 Jul 2008

See all articles by Andrew B. Whitford

Andrew B. Whitford

University of Georgia - Department of Public Administration and Policy

Multiple version iconThere are 2 versions of this paper

Date Written: April 2007

Abstract

Pure incentive schemes rely on the agent's self-interest, rather than more coercive control, to motivate subordinates. Yet most organizations, and in particular public agencies, rely very little on pure incentive contracts and instead use coercive mechanisms of monitoring and sanctioning that many theorists find objectionable. We use principal-agency theory to investigate the problem. Principal-agency theory has tacitly assumed throughout that it is in the principal's interests to find a set of incentives that induce efficient levels of effort from the agent. We show that this is not necessarily the case. We identify a problem we denote as "the principal's moral hazard constraint" in which bonuses large enough to produce the efficient incentive effect are prohibitively expensive for the principal. Potential solutions to this problem - involving penalization or joint ownership - are unavailable in the public sphere. This means that for a large class of control problems in agencies, the principal's self-interest will result in the inefficient use of monitoring and oversight rather than outcome-contingent incentives. Although monitoring is often thought of as resulting from the agent's moral hazard, it can just as reasonably be seen as resulting from the principal's moral hazard.

Suggested Citation

Whitford, Andrew B., The Principal's Moral Hazard: Constraints on the Use of Incentives in Hierarchy (April 2007). Journal of Public Administration Research and Theory, Vol. 17, Issue 2, pp. 213-233, 2007, Available at SSRN: https://ssrn.com/abstract=1161794 or http://dx.doi.org/10.1093/jopart/mul004

Andrew B. Whitford

University of Georgia - Department of Public Administration and Policy ( email )

Athens, GA 30602
United States
706-542-2898 (Phone)
706-583-0610 (Fax)

HOME PAGE: http://andrewwhitford.com

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