Ethics and Agency Theory: Incorporating a Standard for Effort and an Ethically Sensitive Agent

Abstract

We study the implications of introducing ethics into the traditional principal-agent model. In our model, the principal specifies a standard for effort at the time of contracting and the agent suffers a utility loss if he chooses not to provide the standard after agreeing to the contract. The magnitude of the loss depends upon the agent's ethical sensitivity. We demonstrate the emergence of an optimal flat salary contract. We then examine the interplay between ethical sensitivity and firm productivity in determining the optimal salary contact, and contrast it with the traditional incentive solution. Our results are intuitive and help explain a variety of contracting behavior that is inconsistent with traditional agency predictions.

Keywords: ethics, agency theory, productivity, flat salary contracts,

JEL Classification: A31, D82, M14