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

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Author Info
Ernst Fehr (University of Zurich and Collegium Helveticum,)
John A. List (University of Maryland and NBER,)

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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 consider-ably 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 behav-ior. 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. (JEL: C91, C92, J30, J41) Copyright (c) 2004 by the European Economic Association.

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Publisher Info
Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 2 (2004)
Issue (Month): 5 (09)
Pages: 743-771
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Handle: RePEc:tpr:jeurec:v:2:y:2004:i:5:p:743-771

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Michael S. Haigh & John A. List, 2005. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Journal of Finance, American Finance Association, vol. 60(1), pages 523-534, 02. [Downloadable!] (restricted)
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  2. Dufwenberg, M. & Kirchsteiger, G., 1998. "A theory of sequential reciprocity," Discussion Paper 37, Tilburg University, Center for Economic Research. [Downloadable!]
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  3. Camerer, Colin & Weigelt, Keith, 1988. "Experimental Tests of a Sequential Equilibrium Reputation Model," Econometrica, Econometric Society, vol. 56(1), pages 1-36, January. [Downloadable!] (restricted)
  4. Fehr, Ernst & Kirchsteiger, George & Riedl, Arno, 1993. "Does Fairness Prevent Market Clearing? An Experimental Investigation," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 437-59, May. [Downloadable!] (restricted)
  5. Pierre-André Chiappori ; Bernard Salanié, 2002. "Testing Contract Theory : A Survey of Some Recent Work," Working Papers 2002-11, Centre de Recherche en Economie et Statistique. [Downloadable!]
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  6. Frey, Bruno S & Oberholzer-Gee, Felix, 1997. "The Cost of Price Incentives: An Empirical Analysis of Motivation Crowding-Out," American Economic Review, American Economic Association, vol. 87(4), pages 746-55, September. [Downloadable!] (restricted)
  7. Gneezy, Uri & Rustichini, Aldo, 2000. "A Fine is a Price," Journal of Legal Studies, University of Chicago Press, vol. 29(1), pages 1-17, January.
  8. Ernst Fehr & Klaus M. Schmidt, . "A Theory of Fairness, Competition and Cooperation," IEW - Working Papers iewwp004, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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  9. Gary E. Bolton & Axel Ockenfels, 2000. "ERC: A Theory of Equity, Reciprocity, and Competition," American Economic Review, American Economic Association, vol. 90(1), pages 166-193, March. [Downloadable!] (restricted)
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  11. Uri Gneezy & Aldo Rustichini, 2000. "Pay Enough Or Don'T Pay At All," The Quarterly Journal of Economics, MIT Press, vol. 115(3), pages 791-810, August. [Downloadable!] (restricted)
  12. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA. [Downloadable!]
  13. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence And Personal Motivation," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 871-915, August. [Downloadable!] (restricted)
  14. Falk, Armin & Fischbacher, Urs, 2006. "A theory of reciprocity," Games and Economic Behavior, Elsevier, vol. 54(2), pages 293-315, February. [Downloadable!] (restricted)
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  15. Colin F. Camerer & Teck-Hua Ho & Juin-Kuan Chong, 2004. "A Cognitive Hierarchy Model of Games," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 861-898, August. [Downloadable!] (restricted)
  16. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, vol. 83(5), pages 1281-1302, December. [Downloadable!] (restricted)
  17. Berg Joyce & Dickhaut John & McCabe Kevin, 1995. "Trust, Reciprocity, and Social History," Games and Economic Behavior, Elsevier, vol. 10(1), pages 122-142, July. [Downloadable!] (restricted)
  18. Iris Bohnet & Bruno S. Frey & Steffen Huck, . "More Order with Less Law: On Contract Enforcement, Trust, and Crowding," IEW - Working Papers iewwp052, Institute for Empirical Research in Economics - IEW. [Downloadable!]
  19. R. Lynn Hannan & John H. Kagel & Donald V. Moser, 2002. "Partial Gift Exchange in an Experimental Labor Market: Impact of Subject Population Differences, Productivity Differences, and Effort Requests on Behavior," Journal of Labor Economics, University of Chicago Press, vol. 20(4), pages 923-951, October. [Downloadable!]
  20. Bewley, Truman F, 1995. "A Depressed Labor Market as Explained by Participants," American Economic Review, American Economic Association, vol. 85(2), pages 250-54, May. [Downloadable!] (restricted)
  21. James Andreoni & John Miller, 2002. "Giving According to GARP: An Experimental Test of the Consistency of Preferences for Altruism," Econometrica, Econometric Society, vol. 70(2), pages 737-753, March. [Downloadable!] (restricted)
  22. Kreps, David M, 1997. "Intrinsic Motivation and Extrinsic Incentives," American Economic Review, American Economic Association, vol. 87(2), pages 359-64, May. [Downloadable!] (restricted)
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