Eric Van den Steen
Harvard Business School - Strategy Unit
MIT Sloan Working Paper No. 4547-05
I show that an agent's motivation to do well (objectively) may be unambiguously bad in a world with differing priors, i.e., when people openly disagree on the optimal course of action. The reason is that an agent who is strongly motivated is more likely to follow his own view of what should be done. As a result, the agent is more willing to disobey his principal's orders when the two of them disagree on the right course of action.
This effect has a number of implications. First of all, agents who are subject to authority will have low-powered incentive pay. Second, intrinsically motivated agents will be more likely to disobey and less likely to be subject to authority. Firms with intrinsically motivated agents will need to rely on other methods than authority for coordination. Moreover, an increase in intrinsic motivation may decrease all players' expected utility, so that it may be optimal for a firm to look for employees with low intrinsic motivation. Finally, subjective performance pay may be optimal, even when the true outcome of the project is perfectly measurable and contractible.
Through this analysis, the paper identifies an important difference between differing priors and private benefits (or private information): with differing priors, pay-for-performance can create agency problems rather than solving them.
Number of Pages in PDF File: 27
Keywords: differing priors, low-powered incentives, intrinsic motivation, authority, subjective evaluation
JEL Classification: D81, J3, L22, M12, M52
Date posted: June 20, 2005