Principal-agency models are widely employed to examine accountability in hierarchical relationships in politics, business, and other organizational settings. In this theory, one key finding is that a loss of efficiency arises when the cost of monitoring renders direct control over the agent unfeasible. While in political science attention has recently turned to solving the moral hazard problem by perfecting selection mechanisms, attention in business and economic theory generally centers on designing contracts to minimize that loss. However, the information asymmetry between principal and agent requires a contract that shifts risk to the agent to motivate an efficient level of effort. A principal cannot determine whether an outcome (good or bad) resulted from the agent's effort or from circumstances beyond their control. In essence, the principal can assure that the agent sees high effort as being in his/her best interest only by crafting a compensation scheme that makes agent pay heavily dependent upon the outcome.
Intellectual Merit The heart of principal-agency theory is an apparently inevitable tradeoff between efficiency in incentives and efficiency in risk-sharing. Indeed, this tradeoff is inevitable in the absence of trust between principal and agent; it would disappear if the principal could trust the agent to work at maximal efficiency even behind the veil of the information asymmetry. This proposal builds on previous experiments that assessed the use of contingent pay when monitoring of effort levels was impossible, and offer a research design to conduct a valid and reliable test of principal-agency theory's predictions in singe-shot negotiations. The PI extends the design to investigate the effect of a single principal negotiating with a team of agents who undertake joint effort. The PI will design an experiment where a principal negotiates with two agents over a contract's terms, each agent independently chooses an effort level, the experimenter determines the asset value based on effort levels, and the principal and the two agents are paid on the basis of the asset value and the contract. The PI hypothesizes that the principal's ability to obtain high effort from the team depends on the communication context within which the three subjects negotiate the contract. The PI will then vary the communication context to assess the ability of subjects to overcome the tradeoff between efficiency in incentives and efficiency in risk-sharing.
Broader Impacts The concept of a principal incentivizing agents now permeates economic theory, political studies, and organizational life. It is difficult to overstate the impact of the "incentives revolution" on public and private organizations. For example, political scientists have embraced the incentives revolution, both through leveraging the principal-agency framework for studying the role of politics in public administration, and perhaps more importantly in reshaping the public sector through increased use of bonuses and the contracting out of public services. The evidence for or against this role for trust in team production will come from experiments, but it will be no less useful for both advancing our academic understanding of incentives in hierarchical settings and expanding the range of options that real supervisors have at hand when they seek solutions to their immediate supervisory problems.
