The Hidden Costs of Control

We analyze the consequences of control on motivation in an experimental principalagent game, where the principal can control the agent by implementing a minimum performance requirement before the agent chooses a productive activity. Our results show that control entails hidden costs since most agents reduce their performance as a response to the principals controlling decision. Overall, the effect of control on the principals payoff is nonmonotonic. When asked for their emotional perception of control, most agents who react negatively say that they perceive the controlling decision as a signal of distrust and a limitation of their choice autonomy. (JEL D82, Z13) The Hidden Costs of Control By ARMIN FALK AND MICHAEL KOSFELD* We analyze the consequences of control on motivation in an experimental principalagent game, where the principal can control the agent by implementing a minimum performance requirement before the agent chooses a productive activity. Our results show that control entails hidden costs since most agents reduce their performance as a response to the principal’s controlling decision. Overall, the effect of control on the principal’s payoff is nonmonotonic. When asked for their emotional perception of control, most agents who react negatively say that they perceive the controlling decision as a signal of distrust and a limitation of their choice autonomy. (JEL D82, Z13) Principal-agent relations are typically characterized by a conflict of interest. Therefore, principals often use control and incentive devices to eliminate agents’ most opportunistic actions. This paper analyzes how the agent perceives the principal’s decision to control and how this affects the agent’s behavior. We conducted an experiment in which a principal can decide either to trust or to control the agent, where controlling rules out the agent’s most opportunistic actions. Our results show that the decision to control significantly reduces the agents’ willingness to act in the principal’s interest. Explicit incentives backfire and performance is lower if the principal controls, compared to if he trusts. We analyze the interaction of motivation and control in a simple and parsimonious setup. In the game under study, an agent chooses a productive activity x which is costly to him but which increases the principal’s payoff. The distinguishing feature of our experiment is the principal’s decision. Before choosing x, the principal determines the agent’s choice set. He can either leave the choice of x completely to the agent’s discretion, in which case the lowest possible choice of x is zero. Alternatively, the principal can force the agent to choose at least a minimum level x 0. The definition of the agent’s choice set can be interpreted as the degree of control implemented in the agent’s work environment. For example, making it impossible for the agent to choose below x is the equivalent of implementing various control or monitoring devices which restrain the agent from his most opportunistic choices. Not restricting the choice set, on the other hand, represents the absence of such control mechanisms. Alternatively, the restriction of the choice set can also be interpreted as the outcome of a corresponding employment contract. For example, if x represents the amount of working hours, x captures a minimum presence requirement. Similarly, if x stands for the quality of a produced good or service, x is the minimum quality the agent has to deliver. Since x is costly to the agent, standard economic theory predicts that the agent will choose the lowest possible x, which is zero if the principal does not restrict the agent’s choice set, and x 0 if he does. Since the principal’s payoff is increasing in x, he will therefore always be better off controlling the agent than not limiting the agent’s choice set. If, however, there are agents who are intrinsically motivated to perform in the principal’s interest, controlling may actually decrease performance. A potential reason is that agents do not like to be restricted, * Falk: IZA and University of Bonn, Schaumburg-LippeStr. 7-9, D-53113 Bonn (e-mail: [email protected]); Kosfeld: Institute for Empirical Research in Economics, University of Zurich, Blümlisalpstrasse 10, CH-8006 Zurich (e-mail: [email protected]). The authors would like to thank B. Douglas Bernheim (the editor), three anonymous referees, as well as Tore Ellingsen, Christine Falk, Urs Fischbacher, Ernst Fehr, Simon Gächter, Lorenz Götte, Jean Tirole, and Christian Zehnder for helpful comments and suggestions, and Xavier Alonso for excellent research assistance. This paper is part of the University Research Priority Program on “Foundations of Human Social Behavior: Altruism versus Egoism” at the University of Zurich and the EU-TMR Research Network ENABLE (MRTN_CT-2003-505223). Financial support by the University of Zurich and the Swiss State Secretariat for Education and Research is gratefully acknowledged.