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

Journal of Public Administration Research and Theory. 17(2):213-233.

Posted: 2 Mar 2006 Last revised: 20 Jan 2015

See all articles by Gary J. Miller

Gary J. Miller

Washington University in St. Louis - Department of Political Science

Andrew B. Whitford

University of Georgia - Department of Public Administration and Policy

Multiple version iconThere are 2 versions of this paper

Date Written: 2007

Abstract

Pure incentive schemes rely on agent 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. Most organizations rely on the primarily coercive mechanisms of monitoring and sanctioning that many theorists have found objectionable about hierarchy. We identify a problem we denote as "the principal's moral hazard constraint" which can result in an inefficient reliance on monitoring and sanctioning: even when the agent's behavior can be efficiently shaped by a straightforward incentives scheme, the principal's self-interest may stand in the way of implementing it. In these cases, the bonuses large enough to produce the efficient incentive effect are prohibitively expensive for the principal.

One way out of this trap - the penalization of the agent for poor performance - faces general legal restrictions in the public workforce. Another - to form an ownership agreement with the agent - is impossible due to the ownership structure of government. This means that for a large class of control problems in agencies, and hierarchical control problems more generally, institutional designers must rely on more coercive monitoring-based mechanisms for controlling agents. While 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.

Keywords: hierarchies, principal-agency, risk aversion

JEL Classification: D20, D23, L20, L22, L23

Suggested Citation

Miller, Gary J. and Whitford, Andrew B., The Principal's Moral Hazard: Constraints on the Use of Incentives in Hierarchy (2007). Journal of Public Administration Research and Theory. 17(2):213-233., Available at SSRN: https://ssrn.com/abstract=887141 or http://dx.doi.org/10.2139/ssrn.887141

Gary J. Miller

Washington University in St. Louis - Department of Political Science ( email )

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Campus Box 1063
St. Louis, MO 63130
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314-935-5874 (Phone)
314-935-5856 (Fax)

Andrew B. Whitford (Contact Author)

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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