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Journal of Public Administration Research and Theory Advance Access originally published online on August 8, 2006
Journal of Public Administration Research and Theory 2007 17(2):213-233; doi:10.1093/jopart/mul004
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© The Author 2006. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

The Principal's Moral Hazard: Constraints on the Use of Incentives in Hierarchy

Gary J. Miller

Washington University

Andrew B. Whitford

University of Georgia

Address correspondence to the author at aw{at}uga.edu.

Pure incentive schemes rely on the agent's self-interest, rather than more coercive control, to motivate subordinates. Yet most organizations, and in particular public agencies, rely very little on pure incentive contracts and instead use coercive mechanisms of monitoring and sanctioning that many theorists find objectionable. We use principal-agency theory to investigate the problem. Principal-agency theory has tacitly assumed throughout that it is in the principal's interests to find a set of incentives that induce efficient levels of effort from the agent. We show that this is not necessarily the case. We identify a problem we denote as "the principal's moral hazard constraint" in which bonuses large enough to produce the efficient incentive effect are prohibitively expensive for the principal. Potential solutions to this problem—involving penalization or joint ownership—are unavailable in the public sphere. This means that for a large class of control problems in agencies, the principal's self-interest will result in the inefficient use of monitoring and oversight rather than outcome-contingent incentives. Although monitoring is often thought of as resulting from the agent's moral hazard, it can just as reasonably be seen as resulting from the principal's moral hazard.

The authors wish to acknowledge the helpful suggestions of the reviewers and editor of Journal of Public Administration Research and Theory.


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