Shape 14 · also called moral hazard
Principal and Agent
A delegated task with unobservable effort and imperfectly aligned interests.
Two ideas do most of the work. Moral hazard: once insulated from the consequence, the agent takes more risk, because the downside is elsewhere. And measurement distortion: pay for what you can measure and effort flows to the measure, not to the goal — Goodhart in its most expensive form. The characteristic mistake is a monitoring regime that costs more than the misalignment it prevents, and which the agent then games in ways the regime cannot see.
- How it feels
- Somebody is deciding, and somebody else carries the consequence.
- The metric is being met and the underlying goal is not.
- Effort is unobservable, and the outcome is noisy enough to hide it.
- The monitoring is more expensive than the problem it catches.
- Who is playing
- Principal, agent, and the people the task was actually FOR — patients, customers, citizens — who are almost never at the table and whose interests are what the metric was standing in for.
- Where it lands
- Effort concentrates on whatever is measured, the unmeasured parts decay, and everyone reports success while the underlying purpose is served worse than before.
- What moves it
Align by outcome where you can, use several imperfect measures rather than one good one, and consider weakening incentives where the important parts of the job cannot be measured. Sometimes the answer is not a better metric but professional norms and selection.
Not to be confused with
Nearly every misread in practice is a shape mistaken for its neighbour — and each of those mistakes points you at the wrong fix.
Screening and Adverse Selection
Hidden type or hidden action? If you picked the wrong person it is adverse selection; if the right person is behaving differently unwatched, it is moral hazard.
Public Goods and the Free Rider
Is it one agent shirking, or many people all under-contributing? The single-agent fix is a contract; the many-person fix is an institution.
Where you have already met it
Work and Careers
Any bonus scheme. Behaviour goes to the number, and the number was only ever a proxy.
Health and Medicine
Fee-for-service versus capitation. Each pays for a different thing and each produces exactly what it pays for.
Politics and Voting
Elected officials and voters, the textbook case — delegated power, imperfect monitoring, misaligned horizons.
Markets and Money
Fund managers paid on assets under management rather than on returns. The incentive is to grow, not to perform.