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Theories Of Behavior In Principal-Agent Relationships With Hidden Action

  • Claudia Keser
  • Marc Willinger

In Keser and Willinger (IJIO, 2000) we found that many contracts offered by experimental subjects do not satisfy incentive compatibility. While the combination of incentive compatibility and a binding participation constraint would require that the agent incurs a net loss in the less favorable state for the principal, experimental subjects in the role of principals propose contracts in which the agent never risks to make a loss. We identified in the principals’ decision making three basic principles that, combined together, describe a fair offers area into which a large number of the observed contract offers falls. These principles imply that net expected surplus is more evenly allocated between the principal and the agent than agency theory predicts. The aim of the experiments presented in this paper is to test the robustness of these principles when the effort costs increase and the net expected surplus becomes smaller, and to compare their predictive success to the predictive success of agency theory under the assumption either of a risk-averse or a risk-neutral agent. The results show that the fair offers prediction describes the observed contract offers better than agency theory as long as an important net expected surplus is created. However, when the effort costs are so high that the net expected surplus is negligible, standard agency theory does better than the combination of the three principles in predicting the observed contract offers.

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Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2002-07.

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Date of creation: 2002
Date of revision:
Handle: RePEc:ulp:sbbeta:2002-07
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  1. Werner Güth & Wolfgang Klose & Manfred Königstein & Joachim Schwalbach, 1998. "An experimental study of a dynamic principal-agent relationship," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 19(4-5), pages 327-341.
  2. Englmaier, Florian & Wambach, Achim, 2010. "Optimal incentive contracts under inequity aversion," Games and Economic Behavior, Elsevier, vol. 69(2), pages 312-328, July.
  3. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 1997. "Reciprocity as a Contract Enforcement Device: Experimental Evidence," Econometrica, Econometric Society, vol. 65(4), pages 833-860, July.
  4. Axel Ockenfels & Gary E. Bolton, 2000. "ERC: A Theory of Equity, Reciprocity, and Competition," American Economic Review, American Economic Association, vol. 90(1), pages 166-193, March.
  5. Keser, Claudia & Willinger, Marc, 2000. "Principals' principles when agents' actions are hidden," International Journal of Industrial Organization, Elsevier, vol. 18(1), pages 163-185, January.
  6. Vital Anderhub & Simon Gaechter & Manfred Koenigstein, . "Efficient Contracting and Fair Play in a Simple Principal-Agent Experiment," IEW - Working Papers 018, Institute for Empirical Research in Economics - University of Zurich.
  7. Selten,Reinhard, . "Properties of a measure of predictive succes," Discussion Paper Serie B 130, University of Bonn, Germany.
  8. Gérard P. Cachon & Colin F. Camerer, 1996. "Loss-Avoidance and Forward Induction in Experimental Coordination Games," The Quarterly Journal of Economics, Oxford University Press, vol. 111(1), pages 165-194.
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