An Experiment Testing the Behavioral Equivalence of Strategically Equivalent Employment Contracts

A long-acknowledged weakness of using a firm's operations budgeting system for performance evaluations is that much of the information on which the performance will be judged is reported by the individual. A study examines whether the principal-agent model is rich enough to provide useful insights into the interaction between agents' strategic communication and the design of the firm's managerial accounting system. Phase one of the experiment showed that an environment could be created in which skill level preferences for risk and effort and private information can be controlled. In addition, agency-derived Pareto optimal contracts based on the controlled variables can effectively screen agents in the manner predicted by the agency model. Phase 2 showed that subjects' reluctance to misrepresent their skill was overcome, in the majority of cases, by a small monetary advantage. Results support the agency model implication that contracts that are strategically equivalent elicit equivalent behavior from agents faced with a nontrivial monetary incentive to communicate opportunistically.