Analyzing Schools as Firms: What Do the Economics of Organizations and Principal-Agent Theory Say About School Governance and Teacher Pay?

Abstract

This paper applies several fundamentals of the economics of organizations and principal-agent theory to the governance of schools, the use of teacher incentive pay, the performance of schools, and school reform efforts. We analyze schools as we do firms. We then focus on using the results to understand two public policy issues: mandates regarding teacher pay and school competition/choice. An important element is the multitask principal-agent model where rewarding test scores may induce unwanted side consequences. Additionally, since school administrators have a great deal of situation-specific knowledge, school governance is crucial to enable them to act upon this information in appropriate ways. Differences between public and private organizations matter here, since organization administrators have very different incentives in these settings. Our modeling implies that many public school teachers will have attenuated incentives, but distorted towards test scores. Mandates to increase test score rewards might improve poorly performing schools, but only under certain conditions. Institutional reform is an alternative implicitly implied and considered by our approach. Here the goal is to alter schools administrators’ payoff to make them more responsive to educational value produced and less to political influences, thereby inducing more effective teacher incentive systems.