“Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design”, 1991 ():
In the standard economic treatment of the principal-agent problem, compensation systems serve the dual function of allocating risks and rewarding productive work. A tension between these two functions arises when the agent is risk-averse, for providing the agent with effective work incentives often forces him to bear unwanted risk. Existing formal models that have analyzed this tension, however, have produced only limited results.1 It remains a puzzle for this theory that employment contracts so often specify fixed wages and more generally that incentives within firms appear to be so muted, especially compared to those of the market. Also, the models have remained too intractable to effectively address broader organizational issues such as asset ownership, job design, and allocation of authority.
In this article, we will analyze a principal-agent model that (1) can account for paying fixed wages even when good, objective output measures are available and agents are highly responsive to incentive pay; (2) can make recommendations and predictions about ownership patterns even when contracts can take full account of all observable variables and court enforcement is perfect; (3) can explain why employment is sometimes superior to independent contracting even when there are no productive advantages to specific physical or human capital and no financial market imperfections to limit the agent’s borrowings; (4) can explain bureaucratic constraints; and (5) can shed light on how tasks get allocated to different jobs.
The distinguishing mark of our model is that the principal either has several different tasks for the agent or agents to perform, or the agent’s single task has several dimensions to it. Some of the issues raised by this modeling are well illustrated by the current controversy over the use of incentive pay for teachers based on their students’ test scores.2 Proponents of the system, guided by a conception very like the standard one-dimensional incentive model, argue that these incentives will lead teachers to work harder at teaching and to take greater interest in their students’ success. Opponents counter that the principal effect of the proposed reform would be that teachers would sacrifice such activities as promoting curiosity and creative thinking and refining students’ oral and written communication skills in order to teach the narrowly defined basic skills that are tested on standardized exams. It would be better, these critics argue, to pay a fixed wage without any incentive scheme than to base teachers’ compensation only on the limited dimensions of student achievement that can be effectively measured.
Multidimensional tasks are ubiquitous in the world of business. As simple examples, production workers may be responsible for producing a high volume of good quality output, or they may be required both to produce output and to care for the machines they use. In the first case, if volume of output is easy to measure but the quality is not, then a system of piece rates for output may lead agents to increase the volume of output at the expense of quality. Or, if quality can be assured by a system of monitoring or by a robust product design, then piece rates may lead agents to abuse shared equipment or to take inadequate care of it. In general, when there are multiple tasks, incentive pay serves not only to allocate risks and to motivate hard work, it also serves to direct the allocation of the agents’ attention among their various duties. This represents the first fundamental difference between the multidimensional theory and the more common one-dimensional principal-agent models.