Self-Interest, Altruism, Incentives, & Agency Theory

Topics: Principal-agent problem, Evolutionary psychology, Human behavior Pages: 19 (5976 words) Published: February 29, 2012
Michael C. Jensen
Harvard Business School

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 to the costs generated by conflicts of interest between people. Key words: Human behavior, Rationality, Altruism, Self Interest, Perfect Agents, Sociology, Agency Costs © Copyright 1994. Michael C. Jensen. All rights reserved. Journal of Applied Corporate Finance, Vol. VII, no. 2 (Summer 1994). also published in Michael C. Jensen, Foundations of Organizational Strategy, Harvard University Press, 1998 You may redistribute this document freely, but please do not post the electronic file on the web. I welcome web links to this document at I revise my papers regularly, and providing a link to the original ensures that readers will receive the most recent version. Thank you, Michael C. Jensen

Michael C. Jensen* Harvard Business School Journal of Applied Corporate Finance, Vol. VII, no. 2 (Summer 1994). also published in Michael C. Jensen, Foundations of Organizational Strategy, Harvard University Press, 1998

1. Introduction In “Incentives, Rationality, and Society” Michael Brennan (1994) attacks the use of incentives for executive compensation and, indirectly, for use in society in general. Professor Brennan argues that economics views rational behavior as self-interested and that this proposition is wrong both in a positive sense (that is people don’t behave that way) and in a normative sense (because if they did behave in a self-interested way, the world would be a more brutish and undesirable place). Brennan is correct that people do not always behave in a rational way, but this fact provides no support for his opposition to incentives, or his opposition to self-interest. Professor Brennan’s arguments, although popular in many quarters, are, I believe, logically and empirically incorrect. Underlying his argument is a strong aversion to incentives, an opposition that reveals itself in several places to be primarily, if not wholly, an antagonism to the use of monetary...
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