Banking solves the principalâ€“agent problem with incentive contracts which assume a Homo Economicus representative agent. However, professions can solveÂ the principalâ€“agent problem by assuming a â€˜Reasonable Personâ€™ representative agent, from tort law, who reliably tells the truth about hidden action. We describe a non-virtuous circle in finance, which is a negative feedback loop between motivation crowding out arising from incentive contracts, and the subsequent need to offer incentive contacts because agents change from the Reasonable Person to Homo Economicus. We prescribe less reliance on incentive contracts in the practice of finance, and on Homo Economicus in the theory of finance.
|Publication status||Published - 2019|