On the Design of Incentives in Business Firms—A Survey of Some Research

Abstract

Quantitative approaches to the design of incentives in business firms are surveyed by drawing on writings from management science, finance, decision analysis, and mathematical economics. Two general incentive design situations are considered: How should incentives for the company president be designed, so that he or she will be induced to act in the interest of the ownership group or some other controlling syndicate? And how should incentives for divisions be designed, so that they will be induced to act in accordance with the interest of the whole firm? With respect to the first question, the following topics are discussed: the construction of an objective function for the firm derived through die stock market or directly from the preferences of the members of the controlling syndicate, the principal-agent situation, and the moral hazard situation. With respect to the second question, two topics are treated: the Soviet incentive scheme, and resource allocation.