The Hidden Costs and Returns of Incentives - Trust and Trustworthiness Among CEOS

34 Pages Posted: 27 Mar 2003

See all articles by Ernst Fehr

Ernst Fehr

University of Zurich - Department of Economics

John A. List

University of Chicago - Department of Economics

Abstract

We examine experimentally how Chief Executive Officers (CEOs) respond to incentives and how they provide incentives in situations requiring trust and trustworthiness. As a control we compare the behavior of CEOs with the behavior of students. We find that CEOs are considerably more trusting and exhibit more trustworthiness than students - thus reaching substantially higher efficiency levels than students. Moreover, we find that, for CEOs as well as for students, incentives based on explicit threats to penalize shirking backfire by inducing less trustworthy behavior - giving rise to hidden costs of incentives. However, the availability of penalizing incentives also creates hidden returns: If a principal expresses trust by voluntarily refraining from implementing the punishment threat, the agent exhibits significantly more trustworthiness than if the punishment threat is not available. Thus trust seems to reinforce trustworthy behavior. Overall, trustworthiness is highest if the threat to punish is available but not used, while it is lowest if the threat to punish is used. Paradoxically, however, most CEOs and students use the punishment threat, although CEOs use it significantly less.

Suggested Citation

Fehr, Ernst and List, John A., The Hidden Costs and Returns of Incentives - Trust and Trustworthiness Among CEOS. Available at SSRN: https://ssrn.com/abstract=364480 or http://dx.doi.org/10.2139/ssrn.364480

Ernst Fehr (Contact Author)

University of Zurich - Department of Economics ( email )

Blümlisalpstrasse 10
Zuerich, 8006
Switzerland
+41 1 634 3709 (Phone)
+41 1 634 4907 (Fax)

John A. List

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
United States

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