An Experimental Market Investigation of the Effectiveness of an Optimal Agency Contract

In this dissertation, I conduct experimental labor markets to investigate the effectiveness of an optimal agency contract in inducing employee effort and maximizing firm profit. I compare firm profit under the optimal agency contract to that under a theoretically sub-optimal contract that relies on the norm of reciprocity to motivate employee effort, and explore how factors outside standard agency models affect the relative profitability of the two contracts. Experimental results show that firm profit is higher under the optimal agency contract in markets where only one of the two contracts is available, but is statistically indistinguishable between the two contracts in markets where both contracts are available. These results are inconsistent with the assumptions of agency theory, but are consistent with my proposition that employees'perceptions about the intentions underlying firms' contract offers, which play no role in standard agency theory, influence employees' reactions to the offers, and that this, in turn, affects the relative profitability of the two contracts. The implications of these results for research on incentives, contracting, and social norms, and for the design of management control systems in practice, are discussed.