Sanctions and rewards with a motivated agent

This paper provides a simple framework for determining whether a principal should use external incentives (i.e., rewards and sanctions) when such incentive schemes affect an agent's intrinsic motivation to engage in a mission and discusses the welfare effects. We show that (a) when the agent needs to participate in the mission, the principal should use only sanctions, which generate excessive effort relative to the socially efficient effort level. However, if the principal must consider the agent's outside options and (b) when the reward encourages intrinsic motivation, the principal should use only rewards, which also generate excessive effort; and (c) when the reward discourages intrinsic motivation, the principal should use both rewards and sanctions, leading to insufficient effort. These findings are helpful for identifying appropriate carrot and stick strategies in public/private organization management practices and public/private reform programs.