Measuring and Managing Performance in Organizations

Chapter Eight. Designing Incentive Systems

The discussion thus far has focused on the agent. Now we turn to the principal to ask how she behaves in this two-dimensional situation. As before, the principal wants to maximize profit (defined as the difference between revenue generated by agent effort and the amount to be paid the agent). To increase revenues, she wants to increase value to the customer. Like the agent, she knows what the customer wants (the shape of his same-value lines, best-mix path, and so on) and wants to give him what he wants.¹ But she is also wary of the increasing costs as the agent expends more and more effort. As has already been described, she can compare costs and revenues that would result from each allocation of effort ...