Are Trust-based Contracts Efficient? Evidence from a Randomized Policy Experiment∗

Results in behavioral economics suggest that material incentives can crowd out motivation if agents are mission-oriented rather than self-interested. We test this prediction on a sample of nonprofit organizations in Sweden. Traditionally, the contract with the main principal (the Swedish foreign aid agency) has been based on trust and self-regulation. We designed an experimental policy intervention, effectively replacing the trust-based contract with an increased level of monitoring from the principal, along with a threat to cut future funds if irregularities were detected. The experimental intervention was completely framed within the natural policy context. Overall, using both self-reported and observed measures of outreach, we find that the intervention improved efficiency. Organizations in the treatment group are more likely to return unused grants to Sida whereas nonmonitored reveal a distinct tendency to maximize expenditure. In addition, we find no crowding out of private contributions and no evidence of a “discouraged