The Varieties of Incentive Experience 1 Abstract : The Varieties of Incentive Experience

The Varieties of Incentive Experience We often speak of incentives as if there is only one kind, when in reality there are many. This study uses the financial crisis of 2007-2012 as a laboratory for examining the variety of incentives and distinguishes five key types of incentives. First, are natural incentives in which purely non-human conditions provide incentives to act in certain ways. Second, " strictly-speaking " incentives arise when one party makes a specific conditional offer of something of value in order to elicit a particular behavior. Third, socially-emergent incentives arise out of the interplay of human elements to create conditions that make certain behaviors attractive, but that do so without anyone intentionally creating those incentives. Fourth, governmental and other human institutions intentionally create institutionally-constructed incentives to induce particular behaviors, and these incentives are often accompanied by a host of unintended consequences. That is, the institutionally-constructed incentives to do one thing also constitute socially-emergent incentives to do other things that are completely unintended. Fifth, and finally, cooperative-game incentives are a type of socially-emergent incentive. These incentives give two or more parties incentives to pursue a particular course of action while, often, denying that the behavior is related to the incentives that they confront. Fear…. " one tremendous incentive to self-mortification. " 1 —William James, The Varieties of Religious Experience The most important development in economics in the last forty years has been the study of incentives to achieve potential mutual gains when the parties have different degrees of knowledge. I. Introduction For some decades now, the idea of incentives has played a key role in economics as well as in public policy analyses and implementations. Nonetheless, the intellectual range of this absorption with incentives has been quite limited, despite the importance ascribed to it by Kenneth Arrow's quotation. As Arrow implies, the implicit understanding has been that there are gains to be achieved by parties to an agreement, and while Arrow does not specify that the agreement has exactly two parties, the most typical context studied in financial economics, at least, has been the problem of incentive alignment between a principal and the principal's agent. Thus, in their article, " Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, " we find Jensen and Meckling stating: " The principal can limit divergences from his interest by establishing appropriate incentives for the agent and by incurring monitoring costs …