Agency Theory and Intrinsic Motivation
| Nicolai Foss |
Agency theory represents one of the most influential and controversial bodies of microeconomics. To some, it is an extraordinarily powerful theory that can be applied in all sorts of ways and provides the theoretical foundation for the understanding of reward systems, many contractual provisions, the use of accounting methods, corporate governance, etc. To others (e.g., Bob, Jeff, and Alfie), it is the brainchild of overly cynical economists, responsible for most evil in the World, including bad managerial practices and Enron.
Motivation theorists with a psychology background have traditionally been (extremely) skeptical of agency theory: Its view of motivation as extrinsic, its assumption that expending labor is associated with disutility, and its view of explicit monetary incentives as motivators fly, it is alleged, in the face of all sorts of psychological evidence. In particular, the motivation crowding effect (explicit incentives driving out intrinsic motivation), first examined in a lab setting by Edward Deci in the beginning of the 1970s, has attracted much attention, particularly in management research, although many economists (Bruno Frey, Armin Falk, and others) have made much out motivation crowding.
Intrinsic motivation theory (and the crowding effect) may, if true, represent a powerful critique of agency theory and indict it as “bad for practice.” However, it is necessary to understand the somewhat limited thrust of the intrinsic motivation critique. For example, there is no claim (in the relevant psychology research) that all motivation goes away, even if intrinsic motivation is “killed” by explicit incentives. (Popularizers of the notion of intrinsic motivation, however, often reason in this way). There is also no claim that intrinsic motivation is always and everywhere “good.” Intrinsically motivated employees may be quite opportunistic. The concept of intrinsic motivation (and its implications) is by no means universally accepted by psychologists. Etc.
Regarding implications for agency theory, this issue is specifically handled in a nice paper by Alexis Kunz and Dieter Pfaff, “Agency Theory, Performance Evaluation, and the Hypothetical Construct of Intrinsic Motivation.” Of particular interest for management scholars, the authors criticize the conditions under which those laboratory experiments suggesting the presence of crowding effects take place. The circumstances are such that they can easily be avoided in practice (i.e., by good management). Per implication they can also be avoided by the right monitoring and/or reward schemes. Here is the abstract:
Cognitive evaluation theory and its hypothetical construct of intrinsic motivation are enjoying increasing popularity in the fields of business administration and economics. Consequently, intensifying skepticism towards performance incentives and agency theory is postulated. According to cognitive evaluation theory, it is argued that performance pay may undermine an agent’s intrinsic motivation. In contradiction to agency theory, the principal might be worse off when providing an incentive contract to the agent than without doing so. Since the contention is substantiated by empirical evidence, it seems worrying enough for further investigation. Restricting attention to performance pay in business corporations, the scope of this article is to evaluate whether agency theory faces an urgent need to incorporate the construct of intrinsic motivation and its ‘hidden costs of reward’ as postulated by supporters of the concept. The subsequent analysis reveals good and bad news for agency theory. The bad news is that hidden costs of reward do indeed exist. The good news is that the empirical evidence on undermining effects cannot be interpreted as being contradictory to agency theory. In particular, the antecedents for such effects not only seldomly prevail in business corporations, they are also easily avoidable.