Book Description
We provide a completely endogenous justification for an agent's preference for control or decision making autonomy and analyze optimal incentive contracts in a principal-agent setting with private benefits and principal-agent disagreement induced by heterogenous prior beliefs. Our analysis explains both why managers value autonomy and why it motivates them to perform well. The optimal contract gives the agent a fixed wage, a monetary incentive in the form of a share of the project payoff, possible autonomy over project choice, and possible autonomy over the choice of strategy that affects project success. The optimal contract reveals a sharp difference between private benefits and heterogeneous priors. Monetary incentives and agent autonomy are complementary incentive devices with private benefits, but are substitutes with heterogenous priors. Moreover, private benefits and heterogenous priors interact interestingly in the optimal contract, and there is also an interesting interaction between the agent's autonomy and career concerns. Greater autonomy makes perceptions of the agent's ability more sensitive to project success, so autonomy works through the agent's career concerns to generate positive incentive effects. We use the result of the analysis to provide economic content to the notion of quot;psychological ownership,quot; which is related to the agent's psychic gratification from a sense of control over outcomes, and is distinct from quot;objective ownership,quot; which is linked to the agent's monetary incentives.