Article | Southern California Interdisciplinary Law Journal | fall 2005

Trust and Incentives in Agency

by Ramon Casadesus-Masanell and Daniel F Spulber

Abstract

Contracts between a principal and an agent are not formed in a vacuum. Although formal contracts between a principal and an agent contain explicit incentives for performance, the relationship between a principal and an agent also involves implicit incentives. Three types of forces provide implicit incentives: social norms, legal remedies, and market relationships. These forces create a system of trust that motivates agents to behave in a trustworthy fashion and principals to place their trust in agents. Thus, a complete description of the principal-agent relationship cannot be based on the formal contract alone. The implicit incentives that derive from the social, legal and market context reduce the need to rely on explicit incentives, allowing the principal and agent to reduce transaction costs by writing incomplete contracts.

Keywords: Trust; Motivation and Incentives; Agency Theory; Contracts; Market Transactions; Performance; Relationships; Societal Protocols; Legal Liability; Cost;

Citation:

Casadesus-Masanell, Ramon, and Daniel F Spulber. "Trust and Incentives in Agency." Southern California Interdisciplinary Law Journal 15, no. 1 (fall 2005): 45–104.