Principles versus principal: Reconciling norm compliance and shareholder value

• DOI: http://doi.org/10.1111/jpet.12390
• Author: Bernard Sinclair‐Desgagné
• Published date: 01 April 2020
• Date: 01 April 2020

J Public Econ Theory. 2020;22:449–467. wileyonlinelibrary.com/journal/jpet © 2019 Wiley Periodicals, Inc.

|

449

Received: 2 October 2017

|

Accepted: 24 June 2019

DOI: 10.1111/jpet.12390

ORIGINAL ARTICLE

Principles versus principal: Reconciling norm

compliance and shareholder value

Bernard Sinclair‐Desgagné

Environmental Economics and Global

Governance Chair, HEC Montréal,

Montréal, Canada

Correspondence

Bernard Sinclair‐Desgagné,

Environmental Economics and Global

Governance Chair, HEC Montréal, 3000

Chemin de la Côte‐Sainte‐Catherine,

Montréal, QC H3T 2A7, Canada.

Email: bsd@hec.ca

Abstract

This paper considers situations where an agent (say, a

polluting firm’s CEO) must allocate his nonobservable

effort across two distinct tasks (say, revenue/market

share enhancement and environmental stewardship),

and where two principals (say, the firm’s shareholders

and an external stakeholder) hold diverging viewpoints

on what the best allocation should be. Both character-

istics of this context—multitasking and conflicting

principals—are normally seen as obstacles to strength-

ening the agent’s incentives. This paper proposes a

simple arrangement, based on contingent monitoring

and clawbacks, that can overcome these obstacles.

Under this arrangement, the principals would end up

coordinating their respective incentive schemes so that

the agent considers his two tasks as complementary

utility‐increasing activities. Applications to regulatory

compliance, corporate social responsibility, and innova-

tion management are briefly sketched.

KEYWORDS

common agency, complementary incentives, corporate social respon-

sibility, multitasking, regulatory compliance

JEL CLASSIFICATION

D82; H23; Q58

1

|

INTRODUCTION

A common agency is a situation where several principals have a stake in the actions of a

particular agent. Such a situation occurs frequently. A firm’s shareholders, its other

stakeholders, and a welfare‐maximizing regulator, for instance, are all affected by the decisions

implemented by a CEO. Production and marketing departments of a manufacturing firm must

both cope with the designs provided by the R&D department.

In those situations, it is natural to expect that each principal will try to influence the agent’s

actions. The latter will thus face a set of separate contracts, each one being designed to align the

agent’s preferences with those of a specific principal. Several researchers have now examined

this set of contracts (see Dixit, 1996; Tirole, 2001, for good surveys). An important conclusion is

that it would normally yield low‐powered incentives, that is, the agent’s overall payoff would

turn out to be relatively insensitive to output.

1

This conclusion is based on the presence of two

major obstacles.

2

First, as shown by Dixit (1996), competing principals with different objectives

might counter each others’incentive scheme by encouraging effort only on those specific tasks

that matter to oneself while insuring the risk averse agent against (sometimes even rewarding

him for!) underperforming on the remaining tasks. Second, even if the principals cooperate, the

agent’s job would typically consist in a collection of heterogenous tasks, some of which being

more difficult to monitor than others; in this context, previous work by Williamson (1985),

Holmström and Milgrom (1991), Baker (2002), and others indicate that strong output‐based

incentives would lead the agent to neglect the tasks which are relatively more difficult to

monitor.

3

This paper proposes a simple arrangement that can nevertheless deal with both of these

obstacles simultaneously. This arrangement can be described briefly as follows. Consider two

principals, labeled A and B, who, respectively, assign Task

A

and Task

B

to a common agent.

Let Principal A monitor Task

A

and pay the agent according to output on this task. Let

Principal B—the principled or norm bearing one, in this paper—commit to measure

performance on Task

B

, and to then punish or reward the agent, only when current output

on Task

A

gets above a certain prespecified level. Compensation from Principal B varies

according to the observed results on both tasks, the agent being penalized after displaying low

performance on Task

B

; it is set, however, so that ex ante a rational agent would seek Principal

B’s appraisal.

Intuitively, this arrangement can mitigate the two obstacles mentioned above—multitasking

and competing principals—for the following reasons. First, it makes the amounts of effort

expended on Tasks

A

and

B

complementary in increasing the agent’s total compensation. The

agent is now eager to work harder on Task

A

because this not only raises the expected reward

from Principal A, but also the likelihood of an appraisal by Principal B. Seeking Principal B’s

inspection, however, makes little sense if Task

B

is neglected. The agent would therefore not

increase his effort on one task without putting more effort as well on the other task. The

tendency to adversely specialize which characterizes multitasking and hampers incentive

provision in that context is henceforth alleviated. As long as the agent sees Tasks

A

and

B

as

complementary, furthermore, the incentives set by one principal on her preferred task will also

benefit the other principal. This (designed) positive externality counterbalances an inherent

negative one—all things equal, stronger incentives to work on one task raise the agent’s

1

This theoretically based assertion is consistent, for instance, with the relatively flat wages received by the vast majority of employees in public organizations,

and with the relatively weaker managerial incentives that prevail in countries favorable to a stakeholder view of the firm. The former observation is discussed by

Dixit (1996), the latter by Tirole (2001).

2

An additional one would be the fuzziness of missions and lack of focus that the presence of several active principals often entails (as argued by Dewatripont,

Jewitt, & Tirole, 1999). This obstacle raises important behavioral issues (communication, framing, and so forth) which are beyond the scope of this paper.

3

This often turns out to be the case for tasks relating to environmental compliance, as several authors have shown (see, e.g., Laufer, 1999; Langevoort, 2001,

2015).

450

|

SINCLAIR‐DESGAGNÉ