Instructions and Incentives in Organizations

We propose a different perspective on organizations, emphasizing the role of instructions in providing incentives. In our framework, there is a conflict of interest between a principal and an agent over the course of action. When preferences are aligned over executing a course, the principal can selectively instruct the agent on a preferred course to steer the agent toward it. Because less able (less confident) agents are more responsive to instructions, hiring these types of agents can be beneficial. This steering role of instructions toward a course of action helps us understand why and when firms are reluctant to hire overqualified (high-ability) workers, how worker risk aversion can be valuable to an organization, why instructions, although more likely to be used, are less intense, in more uncertain environments, and why instruction-giving and incentive pay go hand-in-hand. This paper was accepted by Joshua Gans, business strategy.