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IZA
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Distrust – The Hidden Cost of Control
by
Armin Falk, Michael Kosfeld
(July 2004)
published in: American Economic Review, 2006, 96 (5), 1611 - 1630
Abstract:
We show experimentally that a principal’s distrust in the voluntary performance of an agent
has a negative impact on the agent’s motivation to perform well. Before the agent chooses
his performance, the principal in our experiment decides whether he wants to restrict the
agents’ choice set by implementing a minimum performance level for the agent. Since both
parties have conflicting interests, restriction is optimal for the principal whenever the latter
expects the agent to behave opportunistically. We find that most principals in our experiment
do not restrict the agent’s choice set but trust that the agent will perform well voluntarily.
Principals who trust induce, on average, a higher performance and hence earn higher payoffs
than principals who control. The reason is that most agents lower their performance as a
response to the signal of distrust created by the principal’s decision to limit their choice set.
Our results shed new light on dysfunctional effects of explicit incentives as well as the
puzzling incompleteness of many economic contracts.
Text: See Discussion Paper No. 1203
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