Negotiation and Social Exchange between Principal and Agent

The principal-agent problem is fundamental to organization design. A principal must negotiate an incentive contract to motivate a more risk averse agent to undertake costly actions that cannot be observed. In rational choice theory, the problem is solved through an inefficient shifting of risk from principal to agent. However neither field studies nor prior experiments have observed the types of contracts nor the agent response predicted by this theory. Two experiments were conducted to test a modular social cognition theory explanation for this discrepancy. According to this alternative to rational choice theory, individuals have evolved specialized cognitive capabilities for dealing with exchange relations. These very human capabilities do not operate by the same logic as rational choice. Both a study of individual agent decisions to a series of hypothesized contracts in experiment one and the interactive bargaining of experiment two yielded results consistent with the modular theory. The logic of social exchange is quite different from the logic of individual choice or game theory. Implications for theory and practice are considered.