Vorlesung PO9(Falk Kosfeld) .pdf



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The Hidden Costs
of Control

Armin Falk & Michael Kosfeld
American Economic Review 96 (2006): 1611-1630

Ernst Fehr Vorlesung P&O 9

1

Idea of this paper
• Principal-agent relationships are typically
characterized by a conflict of interest.
• Principals therefore often use control and
incentive devices to eliminate agents’ most
opportunistic actions.
• If the principal believes that the agent performs
in his interest, introduction of control devices is
superfluous.

Ernst Fehr Vorlesung P&O 9

2

1

• Controlling makes sense only if the principal
expects the agent to behave opportunistically.
• Exactly for this reason, however, controlling
signals distrust: by controlling the agent the
principal implicitly signals that he does not trust
the agent to abstain from behaving
opportunistically.

Ernst Fehr Vorlesung P&O 9

3

Example: The HP-way (1)
“In the late 1930s, when I was working for
General Electric …., the company was making a
big thing of plant security. … GE was especially
zealous about guarding its tool and parts bins to
make sure employees didn’t steal anything.
Faced with this obvious display of distrust, many
employees set out to prove it justified, walking
off with tools and parts whenever they could. …
When HP got under way, the GE memories were
still strong and I determined that our parts bins
and storerooms should always be open. …

Ernst Fehr Vorlesung P&O 9

4

2

Example: The HP-way (2)
… Keeping storerooms and parts bins open was
advantageous to HP in two important ways. From
a practical standpoint, the easy access to parts
and tools helped product designers and others
who wanted to work out new ideas at home or on
weekends. A second reason, less tangible but
important, is that the open bins and storerooms
were a symbol of trust, a trust that is central to
the way HP does business.”
David Packard (1995)

Ernst Fehr Vorlesung P&O 9

5

Research question
• How does the principal’s decision to control affect
employees’ motivation?
• Does the use of control entail “hidden costs” by
signaling distrust?
• Do principals anticipate these costs?
• Empirical question: experiment
– control (interaction, payoffs, beliefs, …)
– individual differences

Ernst Fehr Vorlesung P&O 9

6

3

Related literature
• Dysfunctional effects of incentives.
• Economics
Gneezy and Rustichini 2000a,b, Gneezy 2004,
Fehr and Gächter 2002, Fehr and Rockenbach 2003,
Fehr and List 2004, Frey 1993, 1997, Ichino and
Mühlheusser 2004, Ellingsen and Johannesson 2005,
Herold 2005

• Psychology
Deci 1971, Lepper and Green 1975, Pittman et al. 1980,
Enzle and Anderson 1993
Ernst Fehr Vorlesung P&O 9

7

Main treatment (1)
• Principal-agent game.
• Agent chooses productive activity x
– e.g., working time
– number/quality of produced items
• x is costly to the agent: c(x)=x
• x is beneficial to the principal: b(x)=2x
• x is “productive”: marginal cost < marginal benefit
• Before the agent chooses x, the principal
determines the agent’s choice set.

Ernst Fehr Vorlesung P&O 9

8

4

Main treatment (2)
• Principal can enforce a minimum level of x equal
to x.
• Or he can leave the decision about x completely
to the agent’s discretion.
• Agent has an endowment of 120, principal has an
endowment of 0.
• Payoffs
ΠP = 2x
ΠA = 120-x

9

Ernst Fehr Vorlesung P&O 9

Principal
control

don’t control

Agent

Agent

x

x

120

0

Ernst Fehr Vorlesung P&O 9

x

120

10

5

Interpretation of the principals
decision
don’t control/trust

control/distrust






minimum presence
requirement
minimum quality/output
“complete” incentive
contract, which makes
choice of x < x
undesirable
locked doors

• free working times
• free choice
• incomplete incentive
contract, which leaves
considerable freedom of
choice
• open doors

Ernst Fehr Vorlesung P&O 9

11

Treatments
• Main treatments:
– x = 5, 10, 20 (C5, C10, C20)
– strategy method for agent

• Control treatments:
– x exogenously given (EX10)
– no strategy method (SR10)
– gift exchange (GE10)

x = 10

• All treatments:





one-shot, anonymous interaction
z-Tree (Fischbacher 2007)
≈ 40-50 minutes, ≈ CHF 25.11
804 subjects (randomly allocated to player roles)
Ernst Fehr Vorlesung P&O 9

12

6

Behavioral predictions (C5-C20)
1. standard economic model
• agent chooses minimal x
• xcontrol > xtrust
• principal controls
2. inequity aversion (e.g., Fehr and Schmidt 1999)
• agent chooses positive x independent of the
decision of the principal
• xcontrol ≥ xtrust > 0
• principal controls

Ernst Fehr Vorlesung P&O 9

13

Behavioral predictions (C5-C20)
3. “control aversion”
• agent reacts negatively to control, i.e., he
chooses less if the principal controls than if
the principal trusts
• xcontrol < xtrust
• principal trusts
⇒ Overall, the impact of control is likely to be nonmonotonic: for low x trust pays, as x rises,
control may give a higher payoff.

Ernst Fehr Vorlesung P&O 9

14

7

0.6

C5: x = 5

Relative frequency

0.5

• Trust
• Control

0.4
0.3
0.2
0.1
0.0
0

2

4

6

8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50

Transfer
0.6

C10: x = 10

Relative frequency

0.5

• Trust
• Control

0.4
0.3
0.2
0.1
0
0

2

4

6

8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50

Transfer
0.6

C20: x = 20

Relative frequency

0.5

• Trust
• Control

0.4
0.3
0.2
0.1
0.0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
Ernst
Fehr Vorlesung P&O 9

32 34 36 38 40 42 44 46 48 50

15

Transfer

1.0

0.9

Cumulative frequency

0.8

0.7

0.6

0.5

0.4

⇒ significant upwards shift
in all treatments (Wilcoxon
signed rank test, p < .001)

0.3

0.2

0.1

0.0
0

2

C 5_t

4

6

8

10

12 14

C 5_c

16

18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 >50

C 10_t

C 10_c

Ernst Fehr Vorlesung P&O 9

C 20_t

C 20_c

16

8

Overall effect
Agents’ choices dependent on the principal’s decision
Treatment

Principal controls

Principal trusts

C5

C10

C20

Average

12.2

17.5

25.4

Median

5

10

20

Average

25.1

23.0

26.7

Median

20

20

30

17

Ernst Fehr Vorlesung P&O 9

30
26.7
25.1
23.0

Average x

25

25.4

20
17.5
15
12.2
10
5
0
0

5

10

x

Ernst Fehr Vorlesung P&O 9

15

20

25

18

9

Agents’ individual reactions

19

Ernst Fehr Vorlesung P&O 9

Reason for negative reaction

“What do you feel, if the principal forces you to transfer at least x?”

0.50
0.45

relative frequency

0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
distrust

lack of
autonomy

greed

Agent shows negative behavioral reaction

understanding

neutral

other

Agent shows no negative behavioral reaction
Data pooled over
treatments (n=209)

Ernst Fehr Vorlesung P&O 9

20

10

Exogenous-control treatment
• EX10: restriction x = 10 is imposed exogenously.
• Strategy space of the agent is identical to the
subgame after control in treatment C10, but the
control decision of the principal is absent.
• If agents are control averse, choices should be
higher in the EX10 treatment.
Agent
• Selfishness and inequity aversion
predict that choices
are the same.
10

x

120
21

Ernst Fehr Vorlesung P&O 9

Control subgame of C10 treatment
EX10 treatment

1.0

Cumulative frequency

0.9
0.8
0.7
0.6
0.5
0.4

C10

EX10

0.3

average

17.5

28.7

0.2

median

10

20

Mann-Whitney test, p < .001

0.1
0.0
0

2 4

6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 >50

x
Ernst Fehr Vorlesung P&O 9

22

11

Principals’ decisions and beliefs
Treatment
C5

C10

C20

control

trust

control

trust

control

trust

Percentage

25.7

74.3

29.2

70.8

47.8

52.2

Average belief

17.8

29.6

19.4

25.7

25.3

34.1

Average
counter-belief

12.8

14.9





10.3

23.0

Average x

12.2

25.1

17.5

23.0

25.4

26.7

“self-fulfilling prophecy of distrust” (Luhmann 1968)
⇒ different firm cultures
Ernst Fehr Vorlesung P&O 9

23

Control in the gift exchange game
• GE10: In addition to implementing a minimum of
x = 10 (or zero), principal also determines the
agents’ wage w.
• w = 10, 30, 60, or 120.
• Agent chooses from [x, 120].
• Payoffs
ΠP = 2x-w
ΠA = w-x
• Strategy method for agent.

Ernst Fehr Vorlesung P&O 9

24

12

GE10:

Principal does not control

Principal controls

Median choice of x

25
20
15
10
5
0
10

Wilcoxon s.r. test,
p<.01 for w≥30

30

w=10
Average x
Principals (%)
No. obs.

60

120

w age

w=30

w=60

w=120

control

trust

control

trust

control

trust

control

trust

10.7

5.0

12.6

10.1

19.1

20.9

31.0

32.6

90

10

57

43

50

50

33

10

7

14

67
3

Ernst Fehr Vorlesung P&O 9

25

Control at the workplace

(questionnaire, n=403, classroom)
Five hypothetical situations:
1. Supermarket
2. Working times at new job
3. Job interview
4. Copy machine (locked doors/HP)
5. Internet use
Two conditions: trust, control (between subjects)
Dependent variable: work motivation
Ernst Fehr Vorlesung P&O 9

26

13

Example: Situation 1
“You began a new vacation job in a supermarket. Your task
is to check the balances in the cash registers in the
evening, meaning that you examine whether the amounts
of money in the cash registers correspond with the entries.
In theory, you could easily swindle the supermarket by
simply removing money from the cash register. You
examined the cash registers conscientiously and without
cheating, and reported the results honestly.”
Condition 1 “On your way home, you realize that you forgot
your umbrella. When you enter the supermarket, you see
the manager, who again examines the amounts in the cash
register.”
Condition 2 “The supermarket manager believes your
information and does not recheck the cash registers.”
27

Ernst Fehr Vorlesung P&O 9

“How high is your work motivation?”
Situation 1

Situation 2

(supermarket)

(working times)

Situation 3

(job interview)

Trust

Manager does
not control
(n=204)

Control
Formal
agreement
(n=204)

Trust

Control

Manager
controls
(n=199)

Asked to meet
obligations
(n=199)

Employer
consults
reference
(n=203)

Employer
believes
information
(n=197)

very low

0.07

0.01

0.03

0.01

0.00

0.01

low

0.31

0.03

0.26

0.14

0.14

0.02

middle

0.36

0.25

0.48

0.30

0.41

0.10

high

0.23

0.60

0.20

0.45

0.39

0.53

very high

0.03

0.11

0.03

0.10

0.05

0.34

Work
motivation

Control

Ernst Fehr Vorlesung P&O 9

Trust

28

14

“How high is your work motivation?”
Situation 4

Situation 5

(locked doors)

Control

Trust

(internet use)

Control

Trust

Work
motivation

Doors locked
(n=199)

Doors open
(n=203)

Internet use
monitored
(n=203)

Internet use
not monitored
(n=199)

very low

0.08

0.00

0.09

0.02

low

0.24

0.07

0.33

0.12

middle

0.41

0.33

0.41

0.42

high

0.25

0.50

0.15

0.42

very high

0.02

0.10

0.02

0.02

Ernst Fehr Vorlesung P&O 9

29

Conclusion
• Explicit contracts entail “hidden costs” of control.
• Reason: the decision to control may signal
distrust.
• Behavioral rationale for the deliberate
incompleteness of contracts.
• Incentive for the principal to disentangle negative
signal from control decision.
Ernst Fehr Vorlesung P&O 9

30

15

• Message is not that trust is always better than
control.
• Overall effect depends on the strength of
incentives (non-monotonicity), the frequency of
types, and framing (Fehr and Gächter 2002).
• Ultimate management goal: develop contracts
that motivate opportunistic agents without demotivating intrinsically motivated ones.

Ernst Fehr Vorlesung P&O 9

31

16


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