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Think Twice Before Going for Incentives: Social Norms and the Principal's Decision on Compensation Contracts
Author(s) -
CARDINAELS EDDY,
YIN HUAXIANG
Publication year - 2015
Publication title -
journal of accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 6.767
H-Index - 141
eISSN - 1475-679X
pISSN - 0021-8456
DOI - 10.1111/1475-679x.12093
Subject(s) - incentive , principal (computer security) , misrepresentation , honesty , distrust , microeconomics , moral hazard , principal–agent problem , business , information asymmetry , salary , actuarial science , norm (philosophy) , economics , social psychology , computer security , finance , computer science , psychology , market economy , corporate governance , political science , law , psychotherapist
Principals make decisions on various issues, ranging from contract design to control system implementation. Few studies examine the principal's active role in these decisions. We experimentally investigate this role by studying how a principal's choice of an incentive contract that may discourage misrepresentation, compared to a fixed‐salary contract, affects the honesty of his or her agents’ cost reporting. Results show that, besides an incentive effect and a principal trust effect, the active choice for incentives produces a negative “information leakage” effect. When principals use incentives, their choices not only incentivize truthful reporting and signal distrust, but they also leak important information about the social norm, namely, that other agents are likely to report dishonestly. Agents conform to this social norm by misrepresenting cost information more. Our results have important practical implications. Managers must recognize that their decisions can leak information to their agents, which may produce unanticipated consequences for the social norms of the organization.