Self-Interest, Altruism, Incentives, & Agency Theory
SELF-INTEREST, ALTRUISM, INCENTIVES, & AGENCY THEORY
Michael C. Jensen
Harvard Business School MJensen@hbs.edu
Abstract Many scholars, business people, policy makers, and religious leaders are suspicious of self-interest and incentives and often oppose the use of incentives to motivate managers, employees, public servants, or the public itself. I address here some of these issues regarding human nature and organizations raised by Michael Brennan (1994) in “Incentives, Rationality, and Society.” I analyze the meaning and role of incentives in the logic of choice and argue that it is inconceivable that purposeful actions can be viewed as anything other than responses to incentives. Money is not always the best way to motivate people. But where money incentives are required, they are required precisely because people are motivated by things other than money. Self-interest does not mean that people have no altruistic motives. And altruism, the concern for the well-being of others, does not make a person a perfect agent who does the bidding of others. This means that agency problems cannot be solved by instilling greater altruism in people (even if we could do so). I also discuss the universal tendency of people to behave in non-rational ways. Though they are Resourceful, Evaluative Maximizers (the REMM model) humans are imperfect in the sense that they have inherited a brain that is biologically structured so as to blind them from perceiving and correcting certain types of errors, primarily those that cause emotional or psychic pain. The result is systematic, non-functional behavior that makes them worse off. I briefly discuss a Pain Avoidance Model (PAM) that complements REMM by capturing the non-rational component of human behavior. This non-rational, behavior is the crux of self-control problems that beset all humans. Recognizing these self-control problems leads to an expansion of agency theory since they are a second major source of agency costs in addition
Michael C. Jensen
Harvard Business School MJensen@hbs.edu
Abstract Many scholars, business people, policy makers, and religious leaders are suspicious of self-interest and incentives and often oppose the use of incentives to motivate managers, employees, public servants, or the public itself. I address here some of these issues regarding human nature and organizations raised by Michael Brennan (1994) in “Incentives, Rationality, and Society.” I analyze the meaning and role of incentives in the logic of choice and argue that it is inconceivable that purposeful actions can be viewed as anything other than responses to incentives. Money is not always the best way to motivate people. But where money incentives are required, they are required precisely because people are motivated by things other than money. Self-interest does not mean that people have no altruistic motives. And altruism, the concern for the well-being of others, does not make a person a perfect agent who does the bidding of others. This means that agency problems cannot be solved by instilling greater altruism in people (even if we could do so). I also discuss the universal tendency of people to behave in non-rational ways. Though they are Resourceful, Evaluative Maximizers (the REMM model) humans are imperfect in the sense that they have inherited a brain that is biologically structured so as to blind them from perceiving and correcting certain types of errors, primarily those that cause emotional or psychic pain. The result is systematic, non-functional behavior that makes them worse off. I briefly discuss a Pain Avoidance Model (PAM) that complements REMM by capturing the non-rational component of human behavior. This non-rational, behavior is the crux of self-control problems that beset all humans. Recognizing these self-control problems leads to an expansion of agency theory since they are a second major source of agency costs in addition
References: Argyris, Chris (1990). Overcoming Organizational Defenses. New York, Allyn and Bacon. Argyris, Chris (1991). “Teaching Smart People How to Learn.” Harvard Business Review (May-June): 99109. Argyris, Chris (1993). Knowledge for Action: A Guide to Overcoming Barriers to Organizational Change. San Fransicso, CA, Jossey-Bass, Inc. Baker, George P., Michael C. Jensen and Kevin J. Murphy (1988). “Compensation and Incentives: Practice vs. Theory.” Journal of Finance 43, no. 3 (July): 593-616. Brennan, Michael (1994). “Incentives, Rationality, and Society.” Journal of Applied Corporate Finance (September). Jensen, Michael C. (1993). “The Modern Industrial Revolution, Exit and the Failure of Internal Control Systems.” Journal of Finance (July): 831-880. Jensen, Michael C. (1995). “Economics, Organizations, and Non-Rational Behavior.” Economic Inquiry . Jensen, Michael C. and William H. Meckling (1976). “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” Journal of Financial Economics 3, no. 4 (October): 305-360. Jensen, Michael C. and William H. Meckling (1994). “The Nature of Man.” Journal of Applied Corporate Finance (Summer). Jensen, Michael C. and Kevin J. Murphy (1990). “CEO Incentives-It’s Not How Much You Pay, But How.” Harvard Business Review 68 (3): 138-153. Larrick, Richard P., Richard E. Nisbett and James N. Morgan (1993). “Who Uses the Cost-Benefit Rules of Choice? Implications for the Normative Status of Microeconomic Theory.” Organizational Behavior and Human Decision Processes 56 (3): 331. LeDoux, Joseph (1994). Emotion, Memory, and the Brain. Scientific American. 270: 50-57. Peck, M. Scott (1978). The Road Less Traveled. New York, Simon & Schuster. Postrel, S. and R. Rumelt (1992). “Incentives, Routines, and Self-Command.” Industrial and Corporate Change 1 : 397-425. Schwert, G.W. (1993). Mark-up Pricing in Mergers and Acquisitions. Rochester, NY, University of Rochester. Smith, Adam (1776). The Wealth of Nations. Edited by Edwin Cannan, 1904. Reprint edition 1937. New York, Modern Library. Smith, Adam (1991). The Theory of Moral Sentiments. Indianapolis, Liberty Press. Thaler, Richard H. and H.M. Shefrin (1981). “An Economic Theory of Self-Control.” Journal of Political Economy (April). Weick, Karl E. (1983). “Stress in Accounting Systems.” Accounting Review LVIII, no. 2 (April).