Abstract
Principal‐agent theory suggests that tighter monitoring will raise an agent's work effort and will be applied provided that transaction costs are low. However, when a psychological contract exists between principals and agents, the agents perceive increased monitoring as an indication of distrust, and this induces them to reduce work effort. This “crowding out effect” is likely to dominate when the relationship between principals and agents is personal, while the “disciplining effect” is likely to dominate when the relationship is abstract, as in a competitive market setting. Empirical evidence from neighbouring sciences and from an econometric study supports this proposition.
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