Trust as an Incentive

Preliminary version The standard principal-agent sometimes often mispredicts how people respond to incentives. In this paper we suggest that the failure is largely due to restrictive assumptions about people’s motivation. If agents are assumed to care about esteem as well as money, the princpal–agent model predicts considerably better. The principal’s behavior, notably the choice of contract, conveys expectations about the agent. These expectations matter to the agent because they affect how the princi-pal will rate the agent’s performance ex post. Pessimistic expectations (distrust) justify poor performance by the agent, in the sense that poor performance is consistent with acceptable esteem. Consequently, strong material incentives can backfire when they signal distrust, and incom-plete contracts and low–powered incentives are sometimes optimal be-cause they signal trust. The model also provides reasons why verbal communication, pure framing, as well as the level of pay, can be power-ful motivators. JEL classification