Abstract
The paper by Thomas Hammond and Gary Miller is an insightful comment on the relevance of budget-breaking incentive schemes to real world organizations. They have made a valuable contribution in considering this line of research within a broader context. Nonetheless, they have not established the invalidity of my theoretical arguments. Therefore, my basic point still holds: that is, theoretically it is possible to show that a bonus-penalty incentive scheme of the sort proposed by Holmström is feasible, despite the principal's incentive to cheat. Regardless, all of this debate may beg the question, since compensation arrangements observed in the real world are rarely of the bonus-penalty type. Linear incentives are far more common, and many compensation schemes do not appear to incorporate optimal incentives. At this point we need more empirical research on the determinants of incentives in organizations. In order to make further advances in this area, a better understanding of the incentive mechanisms actually used in organizations is required.
References
Alchian, A. and Demsetz, H. (1972). Production, information costs and economic organization. American Economic Review 62: 777–795.
Brown, C. (1990). Firms' choice of method of pay. Industrial and Labor Relations Review 43: 165–182.
Camerer, C. and Weigelt, K. (1988). Experimental tests of a sequential equilibrium reputation model. Econometrica 56: 1–36.
Darby, M.R. and Karni, E. (1972). Free competition and the optimal amount of fraud. Journal of Law and Economics 67–88.
De Jong, D.V., Forsythe, R. and Lundholm, R.J. (1985). Ripoffs, lemons and reputation formation in agency relationships: A laboratory market study. Journal of Finance 40: 809–820.
Eswaran, M. and Kotwal, A. (1984). The moral hazard of budget-breaking. Rand Journal of Economics 15: 578–581.
Gaynor, M. and Pauly, M.V. (1990). Compensation and productive efficiency in partnerships: Evidence from medical group practice. Journal of Political Economy 98: 544–573.
Gaynor, M. and Kleindorfer, P.R. (1991). Equilibrium misperceptions. Economics Letters 35: 27–30.
Gaynor, M. and Gertler, P.J. (1992). Moral hazard in partnerships. Manuscript. Baltimore: Johns Hopkins University.
Gibbons, R.J. and Murphy, K.J. (1989). Optimal incentive contracts in the presence of career concerns. Manuscript. Cambridge: Massachusetts Institute of Technology.
Hammond, T.H. and Miller, G.J. (1992). Moral hazard in work organizations: Comment. Public Choice 74: 245–256.
Held, P.J. and Reinhardt, U.E. (1979). Analysis of economic performance in medical group practices. Project report 79–05. Princeton: Mathematica Policy Research, Inc.
Hirshleifer, D. and Rasmusen, E. (1989). Cooperation in a repeated prisoner's dilemma with ostracism. Manuscript. Los Angeles: University of California, Los Angeles.
Holmström, B. (1982). Moral hazard in teams. Bell Journal of Economics 13: 324–340.
Holmström, B. and Milgrom, P. (1987). Aggregation and linearity in the provision of intertemporal incentives. Econometrica 55: 303–328.
Jensen, M.C. and Murphy, K.J. (1990). Performance pay and top-management incentives. Journal of Political Economy 98: 225–264.
Kreps, D., Milgrom, P., Roberts, J. and Wilson, R. (1982). Rational cooperation in the finitely repeated prisoners' dilemma. Journal of Economic Theory 27: 245–252.
Lazear, E. (1989). Pay equality and industrial politics. Journal of Political Economy 97: 561–580.
MacLeod, B. (1987). Behavior and the organization of the firm. Journal of Comparative Economics 11: 207–220.
Milgrom, P. (1988). Employment contracts, influence activities and organization design. Journal of Political Economy 96: 42–60.
Mirrlees, J. (1976). The optimal structure of authority and incentives within an organization. Bell Journal of Economics 7: 105–131.
Putterman, L. (1984). On some recent explanations of why capital hires labor. Economic Inquiry 22: 171–187.
Radner, R. (1980). Collusive behavior in oligopolies with long but finite lives. Journal of Economic Theory 22: 136–156.
Wilson, R. (1985). Reputations in games and markets. In A.E. Roth (Ed.). Game-theoretic models of bargaining. Cambridge: Cambridge University Press.
Author information
Authors and Affiliations
Additional information
Thanks are due to Richard Frank for helpful comments. The usual caveat applies.
This paper has not undergone the review accorded official NBER publications. Any views expressed are those of the author and not those of the National Bureau of Economic Research.
Rights and permissions
About this article
Cite this article
Gaynor, M. More on moral hazard in organizations: Reply. Public Choice 74, 257–262 (1992). https://doi.org/10.1007/BF00140772
Received:
Accepted:
Issue Date:
DOI: https://doi.org/10.1007/BF00140772