The Principal-Agent Model of Organization Control Theory

Abstract

We propose an analytical model that integrates two parallel streams of the literature, agency theory and organizational control theory that deal with related issues. In doing so, we provide new insights into agency theory by introducing the concept of a congruent agent, and new insights into organizational control theory by using a contracting model to analyze behavior and outcome forms of controls. We study outcome-based control, i.e. contracting on the outcome; behavior-based control, i.e. contracting on a signal of effort; behavior and outcome control, i.e. contracting on the outcome and a signal of effort, which is new to the organizational control literature; and clan control, i.e. employing agents with preferences aligned with the principal’s, which is new to the agency literature. To interpret clan control in the context of agency theory, we draw from recent theory and experimental evidence in behavioral economics by distinguishing between two types of agents: a self-interested agent, who behaves as modeled in the traditional agency literature; and a congruent agent, who cares about the principal’s payoff, which can be viewed as a form of “social” preferences in behavioral economics and a form of clan control resulting from “socialization” in organization theory. Corresponding to Ouchi’s (1979) view of organizational control, we analytically investigate conditions under which outcome-based control, behavior-based control, and clan control are optimal. We highlight four key dimensions, outcome uncertainty, behavior uncertainty, task uncertainty, the degree of congruence, in determining the optimal control strategy. Furthermore, we expand to four types of control and perform a simulation analysis that extends our analytical results.