Article | Journal of Economics & Management Strategy | September 2004

Trust in Agency

by Ramon Casadesus-Masanell

Abstract

Existing models of the principal-agent relationship assume the agent works only under extrinsic incentives. However, many observed agency contracts take the form of a fixed payment. For such contracts to succeed, the principal must trust the agent to work in the absence of incentives. I show that agency fosters the advent of intrinsic motivation and trustworthy behavior. Three distinct motivational schemes are analyzed: norms, ethical standards, and altruism. I identify the conditions under which these mechanisms arise, and show how they promote trust. The analysis alters several important predictions of conventional models: total surplus is shared between principal and agent, the first best outcome ensues in highly uncertain environments, the principal is better off the more the agent is risk averse, and larger equilibrium extrinsic incentives need not be associated with larger effort or larger total surplus.

Keywords: Trust; Agency Theory; Relationships; Behavior; Motivation and Incentives; Contracts; Business Model; Emotions; Forecasting and Prediction; Ethics; Standards; Risk and Uncertainty;

Citation:

Casadesus-Masanell, Ramon. "Trust in Agency." Journal of Economics & Management Strategy 13, no. 3 (September 2004): 375–404.