Agency Theory and Intrinsic Motivation

20 November 2007 at 8:00 am Nicolai Foss 13 comments

| 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.

Entry filed under: - Foss -, Myths and Realities, New Institutional Economics, Theory of the Firm.

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13 Comments Add your own

1. Vladimir Dzhuvinov | 20 November 2007 at 2:26 pm

Intrinsic/extrinsic motivation?

I thought motivation is a concept entirely of the human mind, and therefore is always intrinsic. How can a certain “thing” (money, whip, etc.) possibly have any meaning outside our minds?
2. Ty Mackey | 20 November 2007 at 3:52 pm

When I first heard about intrinsic motivation, my thought was “This is great!” Keeping workers happy without paying them is much better than having to pay them to keep them happy.

Of course, intrinsic motivation might be “bad for practice”, since the happy, intrinsically motivated worker has a family at home that can’t eat intrinsic motivation for dinner or wear it on their back. And maybe this whole notion of intrinsic motivation is just a way for the capitalists to oppress the working classes–whenever they come in to the boss’s office to ask for a raise, the boss calls his intrinsic motivation into question.
3. srp | 20 November 2007 at 9:10 pm

Intrinsic motivation can also be a source of effort distortion. If I really like doing one part of my job more than another, and this preference difference across tasks exceeds the productivity difference, then you may want to dampen my ardor for the favorite task.
4. Steve Phelan | 21 November 2007 at 2:53 am

Why is it so hard to conceive a utility function that includes intrinsic and extrinsic drivers?
5. Nicolai Foss | 21 November 2007 at 5:39 am

Vladimir, Why don’t you sample the literature a little bit, before you ask this kind of question? Familiarize yourself with the distinction between motivators and motivation, for example.

SRP, that’s what I meant by saying that intrinsically motivated employees may well by opportunists.

Steve, It is not formally hard. And it is being done, eg., by some of the Zürich folks.
6. Vladimir Dzhuvinov | 21 November 2007 at 8:03 am

Ok, I plead guilty :-)

“one is said to be intrinsically motivated to perform an activity when one receives no apparent reward except the activity itself” — Edward Deci
7. dhoopes | 21 November 2007 at 1:18 pm

The motivation literature is huge. I don’t think anyone should be susrprised that many things besides money move people. Think about teenagers. All they care about is what their friends think. Or think about academics, most of us could make a lot more money doing something else. Eisendhardt wrote an AMR paper around 1989 that examined the results of Org Theory control work and agency theory. I’ll let you find out for your self what she discovered.

Nevertheless, the idea that you would like managers and owners to have incentives aligned still has merit. In the family business literature it has been shown that businesses with adequate controls are less likely to suffer from one group of owners exploiting another group.

One important difference between motivation studies and agency studies is level of analysis. Motivation studies tended to look at the how to best reward individual workers. Agency theory tends to look at top management.
8. Maria | 15 July 2009 at 6:35 am

what about intrinsic\extrinsic motivation for the activity of organization? may firm have intrinsic/extrinsic motivations? Does anybody know the literature about it?
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11. Garagegymplanner | 15 December 2016 at 12:29 am

Behavior that is driven by internal rewards, the motivation to engage in a behavior arises from within the individual because it is intrinsically rewarding this refers to Intrinsic motivation

Behavior that is driven by external rewards such as money, fame, grades, and praise, motivation arises from outside the individual, as opposed to intrinsic motivation, which originates inside of the individual this refers to Extrinsic motivaton.
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