Moe 1984

The New Economics of Organization
Author(s): Terry M. Moe

Source: American Journal of Political Science, Vol. 28, No. 4 (Nov., 1984), pp. 739-777
Published by: Midwest Political Science Association
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TheNewEconomicsofOrganization*
TerryM. Moe, Stanford

University
Overthelasttenyearsorso, an important
newapproachtothestudyoforganizations hasemerged
withineconomics.It is perhapsbestcharacterizedby threeelements:a contractual
perspective on
organizational a theoretical
relationships, focuson hierarchical
control,andformalanalysisvia prin-
cipal-agent
models.This paperprovidespoliticalscientists
withan overviewofthe"new economics
of organization"andexploresitsimplications
forthestudyofpublicbureaucracy.
So far,positivepoliticaltheory has notcontributed muchto ourunderstand-

ingofpublicbureaucracy. In partthisis due to theunsympathetic treatment that
rationalmodelingand mostothermodesof quantitative analysishave longre-
ceivedfromstudents ofpublicadministration. Theothersideofthecoin,however,
is thatpositivetheorists havenotmademuchof an effort to developtheoriesof
bureaucracy. Theirconcerns havecentered aroundtwobasicmechanisms ofsocial
choice,votingandmarkets, andtheyhavedevotedlittlesystematic attention to a
thirdmechanismthatis clearlyimportant forunderstanding how societiesand
otheraggregates makecollectivedecisions.This thirdand relatively unexplored
mechanism is hierarchy.
Movement towarda positivetheory ofhierarchies would
filla seriousgap in thesocialchoiceliterature, whileat thesametimemakinga
theoretical contributionthatstrikesto theessenceof publicbureaucracy, indeed
of all organizations.
In fact,significant stepstowarda positivetheoryof hierarchies havevery
recently been taken-butby economists, notpoliticalscientists.In smallnum-
bers,ofcourse,economists madecontributions tothestudyofpublicbureaucracy
sometimeago withthepioneering worksofDowns(1967), Tullock(1965), and
Niskanen(1971). Butthisnewwaveoftheoretical workis different.It is already
a large,complexbodyofliterature thatis thefocusofinnovation andexcitement
amonga growingnumberof economists,and it reflectsan unusualdegreeof
theoreticalcoherence andcumulative Workinthistradition
effort. tendstoreceive
orientationfroma distinctive economicapproachtotheanalysisoforganizations,
an approachperhapsbestcharacterized bythreeelements: a contractual perspec-
tiveon organizational relationships,a focuson hierarchical control,and formal
analysisvia principal-agent models.This approachhas emergedfromrecentat-
tempts to movebeyondtheneoclassicaltheory of thefirm,whichassumesaway
all organizational considerations,to a theoryof economicorganizations thatcan
explainwhyfirms,corporations, andotherenterprises behaveas theydo. Propo-
*For theirusefulcommentsand criticisms,

I wouldlike to thankJonathan
Bendor,Thomas
Hammond,WilliamNiskanen,JohnScholz,BarryWeingast,anonymous reviewers,
and, aboveall,
GaryMiller,whocollaborated
withme on thelargerpaper(MillerandMoe, 1983b)fromwhichthis
articlederives.

740 TerryM. Moe
nentsareenthusiastic-andnotonlyaboutitspromiseforelaboratingthetheory
on revolutionizing
of thefirm.Theyare clearlyintent thewholeof organization
theory.
The lastdecadehas beenmarkedby a growinginterestin organizations
withintheeconomics
profession. The scienceof organizationsis stillin its infancy,
butthefoundation
fora
powerful oforganizations
theory is beingputintoplace. (Jensen,1983)
Mycentralpurposehereis toprovidepoliticalscientists withan overview of

theneweconomicsof organization. Because, withsomeexceptions (due almost
entirely tothelongstanding ofMitnick,1973, 1980),workinthistradition
efforts
has givenvirtually no attentionto publicbureaucracy, it seemsfairto say that
mostpoliticalscientists are currently
unawareof thesenew developments or at
leastareunfamiliar withthem.My reviewis designedas an introduction, stress-
ingbasic conceptsand arguments without dwellingon complicating details.
Twoadditional purposesarepursuedalongtheway.The firstis theapplica-
tionofthisnewanalytical framework to publicbureaucracy, withattentionto the
kindsof methodological and modeling issues thatarisein making the transition
fromeconomicsto politics.The secondis thecomparison of thisnewtradition
withan alternative perspective,also withrootsin economics,thatis doubtless
themostpopularapproachto organizations amongpoliticalscientists: thebehav-
ioraltradition associatedwithSimon(1947), Marchand Simon(1958), Cyert
andMarch(1963), andCohen,March,andOlsen(1972). Despiteareasof over-
lap, it seemsclearthatthesearedestinedtobe themajorcompeting perspectives
in theanalysisofpublicorganizations, andwe mustbeginto assesstheirrelative
strengths andweaknesses.
The EconomicTheoryof Organization
The neoclassicaltheory of thefirmis notin anymeaningful sensea theory
of economicorganization. It centersaroundtheentrepreneur, a hypotheticalin-
dividualwho,by assumption, makesall decisionsforthefirmand is endowed
witha rangeofidealizedproperties defining hisknowledge, goals,computational
skills,and transactioncosts. Virtuallyall aspectsof businessenterprise thator-
ganization findinteresting
theorists andconsequential-from formalstructure to
socialcontextandworker psychology toboundedrationality, adaptivesearch,and
goal conflict-arethereby assumedaway.The modelfirmis simplya blackbox
thatproducesoptimalchoicesautomatically as a functionof anygivenenviron-
ment.
themoregeneraltheory
Similarly, ofperfect competitionis notin anymean-
ingfulsensea theory of competition. Industries are assumedpopulatedby large
numbers offirmsthattakepricesas givenandmakechoiceswithout anyreference
to thebehaviorof others.The interactive, highlystrategicprocesswe ordinarily
associatewithcompetition is entirelymissing,as are theorganizational forms
and market-structuring devices-e.g., verticalintegration, tie-insales, resale
pricemaintenance-that firmsoftenadoptin responding to the uncertainties,

THE NEW ECONOMICS OF ORGANIZATION 741
externalities,and transaction costsinherent in actualcompetitive environments.

As Demsetz(1982) has suggested, itis less a theory ofcompetition thana theory
of decentralization-that is, a theoryof howatomizeddecisionalunits,without
any mechanismof centralcoordination otherthanthe free-market systemof
prices,can produceoutcomesthatare optimalforthecollective.The lessonsto
be learnedarelessonsaboutpricesandmarkets, notaboutcompetition.
Thesemodelsareeasilycriticized. Butthisis notneworevenverydisturbing
to mainstream supportersof neoclassicaltheory, sincethetheorywas neverin-
tendedto be realisticin its assumptions norto be accuratein its micro-level
implications forindividuals andorganizations. Itsdevelopment anduse byecon-
omistshavegenerally beengrounded on itsvaluein deriving formal implications
formarket pricesandoutputs, resourceallocation,equilibria,andotheraggregate
properties ofeconomicsystems.Assumptions aboutthefirmandperfect compe-
titionare simplyvehiclesby meansof whichtheseendsare pursued(Friedman,
1953;Moe, 1979).
Moreover, thesetextbook components ofneoclassicaltheory havegivenrise
overseveraldecadesto an enormous, richlydiversebodyofeconomictheory that
does addressmanyoftheobviousgaps in thesimplemodelsthemselves. A great
deal of workhas beendoneon theeconomicsof imperfect competition, address-
ingnotonlyfamiliarsystem-level issuesof allocationand social optimality, but
also issuesof strategy and competitive process-e.g., in theanalysisof oligo-
polisticcompetition. Oftenthishas involvedthe applicationof new analytical
approaches, suchas gametheory, designedto provideinsight intoeconomiccon-
textsinvolving interaction.
strategic A morerecentbodyofworkis in theareaof
information economics,whichcenters on uncertainty anditsimplications foreco-
nomicbehaviorand markets. Arrow(1953) and Debreu(1959) havegeneralized
thetheoryof perfectcompetition by derivingits equilibrium properties under
conditions ofuncertainty.Othershaveinvestigated a rangeofissuesthatnaturally
takeon relevancewhendecision-makers are less thanperfectly informed-e.g.,
optimalsearchand information transfer (Stigler,1961), optimalsharingof risks
(Arrow,1971; Wilson,1968; Spenceand Zeckhauser,1971), rationalexpecta-
tions(Muth,1961), and signaling(Spence, 1974). Currently, theeconomicsof
information is perhapsthefastest growing areaofmicroeconomic theory (Hirsch-
leiferandRiley,1979).
Whilethesedevelopments onlyscratchthe surface,theyhelp to illustrate
thatthesimplemodelsat thecoreofneoclassicaleconomicsareultimately notso
simpleafterall-and notso easilycriticized-having beengeneralized to yielda
complex,highlyvariedbodyoftheory. This is less a unifiedneoclassicaltheory
thana largefamilyof diversetheoriesrelatedby sharedanalyticalfoundations,
chiefamongthem:a focusontheindividual as theunitofanalysis;theassumption
ofrational,utility-maximizing behavior;a concernforefficiency, optimality, and
equilibrium; and a preference formathematical modelingoverotherapproaches
to theoryconstruction. Manycriticisms of simpleeconomicmodelsare not(or
shouldnotbe) criticisms of neoclassicaltheory perse, sincetheweaknessesand

742 TerryM. Moe
omissionsof whichthesemodelsare accusedcan oftenbe handledwithinthe

broaderneoclassicalframework. The mostunsettlingcriticisms-from behavior-
or Marxists,forinstance-arethosethatchallengethe
alists,institutionalists,
foundations thatneoclassicaltheories share,forthesepointto deficien-
generally
cies thatmaycall forshiftsto new and perhapsmarkedly different theoretical
approaches.Giventhemagnitude of theedificetheythreaten,it is littlewonder
thatthesealternative
viewshavehada difficulttimeattractingmainstream support
or evenseriousattention.
fromtheNeoclassicalViewoftheFirm
EarlyDepartures
Muchof theeconomictheory of organizations has emergedin thelastten
yearsor so and is theproductof writers whosemethodsand theoretical orienta-
tionsare largelyconsistent withneoclassicaltradition. Nonetheless, theorigins
and basic themesof theneweconomicsof organization havebeen shapedmost
fundamentally bythepioneering viewsofthreeearlydissenters fromtheneoclass-
ical theoryof thefirm:RonaldCoase, HerbertSimon,and ArmenAlchian.A
briefreviewof someof theirideasprovidesa usefulintroduction to morerecent
developments.
Coase was amonga diversegroupof economistswho contendedthatan
understanding of economicactivity requiredsystematic inquiryintotheinstitu-
tionalcontextin whichsuchactivity takesplace. Whileothersemphasizedlegal
institutions(Commons,1934) and otherstructural aspectsof theenvironment,
Coase focusedon thefirmitself,and, in his classic article"The Natureof the
Firm"raiseda fundamental question:whydo theseorganizations exist?Whydo
economicagentsin realeconomiccontexts tendto arrangethemselves hierarchi-
callyandcoordinate theirdecisionsvia centralauthority rather thanrelying upon
voluntary exchangeandtheautomatic coordination providedbythemarket?
His answer-thathierarchy is oftenmoreefficient-isunsurprising, butfar
less important thantheway he goes aboutconstructing it. He notesthatreal-
worldproduction processesofanycomplexity generally involvemanytransactions
amongownersof capital,labor,land,specializedknowledge,and otherinputs,
and thatthesetransactions are costly.In a hypothetical worldin whichall pro-
ductionis carriedoutpurelyby meansof market relationships, transactioncosts
oftwotypesareparticularly important. First,an agentinterested in arrangingfor
theproduction of a good mustsomehowlearnthemyriadpricesof relevanceto
thetransactions he entersinto,thussuffering thecostsof information gathering
and evaluation.Second,he experiences costsin preparing for,negotiating, and
concluding separatecontractual agreements foreach transaction. Rationalagents
will naturally seek to minimizethesetransaction costs. The thrustof Coase's
argument is thatmanysuchcostscan oftenbe eliminated orsubstantially reduced
byshifting to an alternative,
nonmarket arrangement thatinternalizes someofthe
agent'stransactions withfactor-owners and altershis contractual arrangements
withthem:

Forthisseriesofcontractsis substituted
one . . . whereby
thefactor,
fora certainremuneration
(whichmaybe fixedor fluctuating) agreesto obeythedirections of an entrepreneur
within
certainlimits.The essenceof thecontractis thatitshouldonlystatethelimitsto thepowers
oftheentrepreneur.Withintheselimits,hecan thereforedirecttheotherfactors
ofproduction.
(Coase, 1937,p. 391)
Thusemergesa rudimentary economicorganization, thefirm, centrally char-

acterizedby theauthority relationand thehierarchical direction of production.
The drivingforcebehindits emergenceis efficiency: economicagentsarrange
production withinfirms-they substituteauthority relationsformarket relations-
in orderto reducetransaction costs and producemoreefficiently. Firmsonly
emergewhenthiscondition is met,andexpandup to thepointwherethecostof
an additionaltransaction withinthefirmbeginsto exceedthecost of thesame
transactionin the market.In equilibrium, some transactions will therefore be
internalizedwithinfirmsof variouskindsand sizes, and somewillbe leftto the
market.
Coase's articlewas, in hisownwords,"muchcitedandlittleused" (Coase,
1972)formorethanthirty yearsafteritspublication. Withthenewwaveofstudies
in the 1970s,however, it was resurrected as a majorsourceof theoretical ideas
that,perhapsmorethananyother,has shapedthefoundations of thisemerging
bodyof workon organizations. Severalof his notionshave provedespecially
influential.
(1) Economicorganizations are bestunderstood by comparing their
efficiencyto thatof themarket.(2) In therealworld,whichis clearlynotchar-
acterizedby perfect competition, perfectinformation, or frictionless exchange,
economicactivities andorganizational arrangements arebestunderstood in terms
of thetransactioncostsinherent in anysystemof exchangerelationships among
rationalindividuals.(3) These relationships are contractual in nature,and the
firmis bestunderstood as foundedupona distinct kindof contractual arrange-
ment,theauthority relation.Thus,in theirearliestcoherent statement, we have
threecentralcomponents of the new economicsof organization: marketsvs.
hierarchy,transactionscosts,andthecontractual natureof organizations.
Simon,unlikeCoase, was notprimarily concemedwithdevelopinga new
theory ofthefirm,although certainlythatqualifiedas one ofhisinterests. Rather,
it seems fairto say thathis workwas motivated by two broaderpurposes:he
soughtto replacetheconventional modelof rationaleconomicmanwithan em-
piricallyadequatetheory of individual choice,andto use thattheory ofchoiceas
a foundationforbuildinga generaltheory oforganization. His workon individual
choice,moreover, was notsimplya meansto movetowarda better understanding
oforganizations. As indicated byhislaterwork(e.g., Simon,1955, 1957, 1969;
Newelland Simon,1972), Simonhas alwaysbeenconcerned firstand foremost
withmodelinghow peoplethink.His departure fromneoclassicism,therefore,
has alwaysbeen groundedon a fundamental challengeto the rationalchoice
paradigm.
AttheheartofSimon'scontribution is hismodelofboundedrationality, first
developedand appliedto organizations in Administrative Behavior(1947). This

744 Terry
M. Moe
modelrecognizesthatpeopleare limitedbothin theinformation andknowledge
theypossessandin thecomputational skillstheybringtobearin makingchoices.
Thus,theycannotengagein thekindof informed optimization attributed to eco-
nomicman,norcan theyengageinthekindofdecisionmakingunderuncertainty
thatinformation economistsand game theorists have subsequently developed.
Instead,boundedly rationalindividuals "satisfice."Thismodeofchoice,in turn,
leads themto behavein a routine,myopic,butreasonably adaptivemanner(see
also Marchand Simon,1958).
Simon'stheory of organization arisesfromthisfoundation. The keyinsight
is that,justas individuals willroutinize behaviorif leftto theirowndevices,so
routines can also be imposedby organizational superiors, whocan takestepsto
shapethedecisionalpremises(information, beliefs,aspiration levels)of subor-
dinatesand providethemwiththeprogrammed responsesdeemedsuitablefor
efficientpursuit oftheorganization's objectives.Itis thiscombination ofbounded
rationality and managerialefforts to programsubordinate behaviorthatlargely
explainsorganizational structure. Individualsthroughout theorganization, pre-
ciselybecausetheyare boundedly rational,willbehavein theroutine, patterned
wayscharacteristic of structured behavior;and(boundedly rational)managers, in
seekingto shapeandcoordinate individual programs intoan organized,efficient
structure, imposebehavioral routines via hierarchy, divisionof labor,communi-
cationsflows,andtraining programs. Thusemergethebasicstructural aspectsof
organization, all ofthemanchoredin theinherent limitationson humandecision-
makers.
Simon's workhas clearlyhad a pervasiveinfluenceon theeconomicsof
organization, but its impactsare moresubtleand less neatlycategorizedthan
thoseof Coase. The reason,it seems,is thatSimon'ssatisficing modeljustdoes
notsitwellwithmosteconomists in thisarea,who,whilewillingto departfrom
neoclassicaltradition in viewingfirmsas organizations, are notwillingto take
thefarmoreradicalstepof rejecting theoptimization modelof choice.This, in
turn,naturally impliesan unwillingness to acceptthetheoretical logicthatdrives
Simon'sorganization theory andsuppliesitsdistinctive features.
The majorlegaciesof Simon'searlyworkare of a moregeneralsort.His
modelof boundedrationality has been influential in arguingtheempiricalrele-
vanceof newelements fromthepsychology of decisionmaking:e.g., memory,
learning,information processing,selectiveattention, adaptation,socialization.
Economists, giventheirinterest in markets, generally finditeasytodismissthese
sortsoffactors as unnecessary complications. Butorganization theorists, includ-
ing economistsnow doingworkon organizations, are directlyconcernedwith
individualbehaviorand interaction amongindividuals,and theyoftenfindthe
psychological aspectsofdecisionmakingimpossibleto ignore.Simon'sachieve-
mentwas his earlydemonstration thatit is possiblebothto takerelevant aspects
of humanpsychology intoaccountand to employaspectsof economicmethod-
ology.Giventhesubstantive concernsof organization theorists,thiswas an in-
sightofgreatconsequence.

He also demonstrated in detailthatan organization theorycan indeedbe

builton individualisticfoundations, andthusthateconomicmodelsandmethods,
appropriately modified, can be ofrealvaluein pursuing a better understanding of
organizations, notsimplyindividuals. Alongtheway,he sheddramatic newlight
on the rationality of routineindividualbehaviorand organizational structure,
showing themtobe theproduct neither ofpathological rule-followingnoroptimal
managerialdesign,butrathera predictable reflectionof the actuallimitations
underwhichhumanbeingsmakedecisions.Bothaspectsofhis work-thevalue
ofeconomicmethods fororganizational analysis,therationalityofstructure-are
nowcornerstone viewsof theneweconomicsoforganization.
Finally,Simonis widelycitedforhis conceptof authority, whichplaysan
integralrolein linkingboundedrationality andorganizational behavior.Herehe
stressedthattheauthority relationis notcharacterized by commandor fiat,as
classicalorganization theoristssuggest,butratheris two-way. The subordinate
has a "zone of acceptance"withinwhichhe willinglyallowstheemployer to
directhisbehavior. Thus,thenatureofauthority relationandwhether orhowwell
itworksdependuponbothpartiesto theagreement. Thisconceptwas developed
in the earlierorganizational workof Barnard(1938)-and, interestingly, it is
virtuallythesameas thecontractual authority relationso centralto Coase's anal-
ysis.Butitis Simonwho,insubsequent workovertheyears,hasbeenresponsible
forexplicating and popularizing theconcept,and it is withhimthattheconcept
is normally associated.
SimonandCoase actuallyhavea goodbitmoreincommonthantheconcept
of authority. Because of this,theirinfluenceson the emergingeconomicsof
organization havebeenreinforcing in important respects.In thefirstplace, they
bothrejecttheneoclassicaltendency to treatorganizations as blackboxeswhose
internalstructuresandprocessesareuninteresting andbeyondtheusefulscopeof
economics;botharguethateconomicoutcomescannotbe understood, evenin the
aggregate, without an adequatetheory of economicorganizations, and thateco-
nomiclogicand methodscan in factbe extendedto thisnewarea of theoretical
inquiry.In thesecondplace,botharguethattherelative efficiency ofhierarchy-
andtheexplanation oforganization-isdue at base to limitations, imperfections,
and frictionsthatshapeindividualchoicein consequential waysbutare omitted
fromthecoreneoclassicalmodels.ForCoase, transaction costslead optimizing
individualsto preferhierarchy to markets.For Simon,uncertainty and limited
cognitive capacitylead humandecision-makers to satisficeand thusto engagein
highlystructured behavior. Bothapproachesareindividualistic, anchoredin eco-
nomicmodelsof choice,andcharacterized bytheincorporation ofnewelements
whosevalueis suggested byempirical observation.
Whilenotapparent in theearlyworkof eitherCoase or Simon,theirtheo-
reticaltraditions
havecomein subsequent yearsto sharean additional component
of trulyfundamental importance, one derivingfromArmenAlchian's classic
article"Uncertainty, Evolution, andEconomicTheory"(Alchian,1950). Thisis
thenotionof naturalselection-or,moregenerally, thenotionthattheexistence

746 Terry
M. Moe
andbehavior of economicorganizations can be understood bya translated appli-
cationofDarwin'sbiologicaltheory of evolution andnaturalselection.
Alchianis also concerned withthe"removalof theunrealistic postulates"
(p. 211) underpinning thetheory of thefirm,as well as withmovingtowardan
understanding offirmsas organizations. He rejectstheassumption ofprofit max-
imizationoutright, arguingthattherecan be no definitive criterion of rational
behavior underconditions ofuncertainty-and that,at anyrate,it is unnecessary
forunderstanding theproperties of economicorganizations and economicsys-
tems.Firmssurviveneither becausetheychooseaccordingto thiscriterion nor
becausetheyachievemaximum profits.Theysurvivebecausetheymakepositive
profits,regardlessof how fartheydepartfromwhatis objectively optimal,re-
gardlessof whether theyarerationalor irrational, brilliant
or dumb.
Firmsthatare well suitedto theparticular conditions of theirenvironment
will be "selected" by theeconomicsystemforsurvival,whiletherestwill fail
anddisappear.Formalstructures, leadership styles,andotherorganizational char-
acteristicsthathappento conduceto profitability in a givenenvironment-even
iftheorganizational participantsarequiteunawareofthecausalconnection-are
thereby selectedforsurvival,withless efficient organizational alternativesfalling
bythewayside.Theresulting population oforganizational forms is notnecessarily
optimal,forthesystemcan onlyselectfromthoseformsthatare actuallytried
by participants, andthereis no guarantee in a worldofuncertainty andbounded
rationalitythatoptimalforms willbe discovered andputintooperation. Nonethe-
less,economicnaturalselection favorsincreasingly "better"organizational forms
overtime,and, in theprocess,it correctsforthemisstepsand myopicchoices
thatinevitably occurat theindividual level.
In fact,thenaturalselectionmechanism doesmorethanthis:itactuallytakes
advantage oftheselower-level blunders in upgrading theefficiency oftheorgani-
zationalpopulation.To a largeextentthisis whateconomicinnovation is all
about.Justas mutation operatesamongbiologicalorganisms, so innovative be-
havior-whether consciousorentirely unintended-generates neworganizational
forms availableforselection bythesystem.Although empiricallycommonmicro-
processesliketrial-and-error, imperfect imitation, and sheerchancemayusually
produceorganizational failure,someportion of thenewformstheyproducewill
tendto be well suitedto environmental conditions and perhapsfarbettersuited
thanexistingforms.The same is truefor"rationally"designedinnovations,
arguably(butnotnecessarily)witha higherprobability of success. Because of
innovations, theuniformity inducedby economicnaturalselectionis dynamic
ratherthanstatic,continually incorporating newformsanddropping old oneson
thebasis ofdemonstrated efficiency.
In a fundamental sense,Alchian'stheory of economicorganizations is dif-
ferentfromthoseofCoase orSimon.He disavowsan explicitmodelofindividual
choice(although it is clearhe favorssomesortof adaptivemodel),andhe offers
a system-level explanation of organizational emergence, structure, and survival
thatis largelyindependent of decisionmakingat themicrolevel.His theoryis

notindividualistic.Yet it is preciselythisindependence of a distinctmodelof
choicethatultimately rendersit compatiblewiththeindividualistic theoriesof
bothCoase and Simon,howeverdifferent theymightbe fromone another, and
thatprovideseachofthemwitha newdimension ofexplanatory power.
Thisis a dimension ofrealimportance. Whether individualsoptimizeunder
uncertaintyor satisfice
underthemorelimiting conditions ofboundedrationality,
theymakechoicesaboutorganizational structures,processes,andbehaviors that
maybe farfromobjectively efficient
andthatmayvarywidelyacrossindividuals
andorganizations. Theoretical coherenceat themicrolevel,therefore, maywell
helpus tounderstand whatis goingon at thatlevelwithout tellingus muchabout
aggregateproperties of thesystemor itspopulation of organizations.Alchian's
logicofnaturalselection,whengrafted ontoeitherapproach,providesa powerful
meansof deriving and integratingexpectations aboutindividuals, organizations,
and systems.The resultin eithercase is an approachthatgains in scope and
coherence,andthatdoes so byremaining trueto itsunderlying modelofindivid-
ual choice.
TheEmerging
Paradigm
The organizational viewsof Coase and Simonhad littleinfluencewithin
economicsformanyyearsaftertheirintroduction. To theextentthattheoretical
workdeparted fromthetextbook neoclassicalmodelbyfocusing onorganizational
concerns,itstilltendedtoreflect themethodsandbroadertheoretical orientations
characteristic
ofneoclassicism as a whole.
Perhapsthebestknownof theseelaborations challengedtheassumption of
profitmaximization, arguingthatan adequateexplanation of businessbehavior
requiresattentionto other,oftenmoreimportant goals thatactualfirmsor their
managers areobservedtopursue.Emphasishasbeenplaceduponsales (Baumol,
1959), the perquisitesand discretionary resourcesof managers(Williamson,
1964), and ratesof growth(Marris,1964), amongotherthings;profitoften
appearsas a constraint,e.g, via a minimum acceptablelevelofprofit,ratherthan
as a valueto be maximized.These efforts clearlydepartfromneoclassicismin
waysotherthantheirrejection ofprofit maximization:bytheirreference to man-
agerialand otheraspectsof organization, forexample,and by theirconcernfor
movingtowarda utility function forthefirmthatbetterrepresentstherealitiesof
thebusinessworld.But thegeneralapproachremainsneoclassicalin its essen-
tials,withthefirm-whatever itsobjectives-stilla unitarydecision-maker that
optimizesoverall knownalternatives.
Another setof elaborations comesfromtheeconomicsof information. This
diversebodyofliterature tookoffduringthe1970s,andmuchofitoverlapswith
withtheneweconomicsoforganization. though,itscontributions
Untilrecently,
wereless distinctivelyorganizational and moreconcerned withdeveloping ana-
lyticalframeworks fortheintegration ofuncertaintyintoneoclassicaltheory(Ar-
row,1971; Stigler,1961). Therewereexceptions-e.g.,MarschakandRadner's
(1972) workon teams,Arrow's(1964) earlyarticleon controlin largeorgani-

748 Terry
M. Moe
zations,and themanagerial application of statisticaldecisiontheoryand opera-
tionsanalysis.Andtherewerea numberof works,less explicitly organizational
in focus,thatprovedseminaltotheorganizational analysisofrecentyears-e.g.,
Wilson's(1968) workon syndicates andSpenceandZeckhauser's(1971) analysis
of insurance, bothof whichdeal withrisksharing.But,as withtheliterature on
goals,workofdirectrelevance toorganizations tendedtoproceedon neoclassical
foundations.
Concerted attempts to bringabouttrueparadigmshiftscame in twoforms:
one a directdescendant of Simon,theothera directdescendant of Coase. The
former was effectively initiatedby Cyertand March'slandmark studyA Behav-
ioralTheoryoftheFirm(1963). This booklaunchesa directattackon thecon-
ventionalmodel by rejectingall its basic components-optimization, profit
maximization, perfect information-in developing "an empirically relevant,pro-
cess-oriented, generaltheory of economicdecision-making by a businessfirm"
(p. 3). Information and goals, no longerfixedby simplifying assumptions, be-
comeendogenous to dynamicdecisionprocessesinternal to theorganization; the
formstheytakeand theirrelevanceto organizational choice are matters to be
explained,giventheempiricalcontextand theoperation of satisficingmodesof
decision.Neoclassicalassumptions are thustransformed intosubtheories. The
resulting theoreticalstructure is characteristicof earlierworkin thistradition by
Simon(1947, 1955, 1957) and Marchand Simon (1958), withemphasison
sequential search,adaptivelearning, programmed behavior, anddynamic process.
But it is perhapsbestknownforthreeof its moreinnovative contributions: (1)
thenotionthatgoals emergeand changeovertimein responseto processesof
coalitionformation amongorganization members;(2) theconceptof organiza-
tionalslack,a resourcecushionof "inefficiency" thatactuallyperforms crucial
positivefunctions in maintaining policycoalitionsandfacilitating smoothorgani-
zationaladaptationto environmental change;and (3) thedemonstration, via a
computer modelof dynamicchoice,thata behavioral theory can in factbe for-
mallymodeledandsubjected(withgreatsuccessin thiscase) to empiricaltest.
Thisalternative paradigm, whilewidelyrecognized, didnotcatchon among
economists.Again, thereare exceptions.The worksof Winter(1964, 1971,
1975) and Nelsonand Winter(1973, 1981) are important attempts to applythis
paradigm,augmented by Alchian's naturalselectionargument, to system-level
issuesofmarkets andinnovation. Also promising is Radner's(1975) formal anal-
ysisof satisficing behaviorin organizational contexts.But thereal influence of
thebehavioral paradigmhas beenamongbehavioral psychologists, politicalsci-
entists,andorganization theorists-whodidnotneedtobe convincedto abandon
simpleneoclassicalmodels,and whowereless disposedto takeadvantageof its
characteristiceconomiclogicand methodology.
In behavioralpsychology theparadigmhas been integralto empiricalre-
searchon humanproblemsolving(Newell and Simon, 1972) and individual
choice(KahnemanandTversky, 1973; Kunreuther et al., 1978), muchof which
has attempted to evaluatetheoretical modelsof decisionmakingby investigating

theactualthought processesof people in variouskindsof decisionalcontexts.
The evidenceto dateappearsto be on thesideof thisaltemative paradigm(see
Simon,1979).
In politicalscienceitsinfluence is mostapparent in studiesof incremental-
ism (Braybrooke and Lindblom,1963), budgeting (Wildavsky,1964; Crecine,
1969; Padgett,1980a), and policymaking (Allison,1972; Steinbruner, 1974)-
although it is oftenthepreferred organizational approach,whatever thesubstan-
tivearea,whenpoliticalscientists findorganization theory relevant to theircon-
cerns.Recentdevelopments are especiallypromising, particularly the workof
Padgett(1980a, 1980b),whosestochastic modelsrepresent a majornewstepin
formal application oftheparadigmto politics.
In organization theoryas a whole,workon thebehavioral paradigmconsti-
tutesa smalland historically not-very-influential partof theliterature, dwarfed
byopensystems analysisandenormous numbers ofcorrelational studieson micro
(e.g., morale,leadership)and macro(e.g., structure, technology, size) organi-
zationaltopics.Butit appearsto be takingon greater prominence, due largelyto
theworkof March,Olsen, and Cohen,who, in a seriesof articlesand books,
havedevelopedandapplieda distinctive versionoftheparadigm(reflecting their
"garbagecan" modelof organizations) thatplaysuponcertainof itsthemes-
especiallytheambiguity (of goals as wellas beliefs)andrandomness inherent in
processesof organizational choice(Cohen,March,andOlsen, 1972; Marchand
Olsen, 1975; Cohenand March,1974; March,1978). These efforts, in combi-
nationwithnew sociologicalperspectives on theenvironment (Pfeffer and Sal-
ancik,1978; Aldrich,1979; HannanandFreeman,1977) andnewdevelopments
in computer modelingof adaptiveorganizational behavior(Cohen, 1981, forth-
coming[1984];CohenandAxelrod,forthcoming [1984]), clearlyare at thefron-
tiersof modemorganization theory.
Despitethelackof enthusiasm withineconomics,then,thebehavioral par-
adigmhas achievedwidespreadrecognition and is trulyinterdisciplinary in the
theoryand researchit has spawned.It has excitingpotential forgrowthwithin
disciplines,butevenmoreexciting is itspotentialfornewandproductive linkages
acrossdisciplines(see, e.g., Marchand Shapira,1982; March,1981). Withall
theworkthathas been carriedout in thelast fewdecades,thevalue of these
linkagesis becomingapparent to increasing numbers of social scientists.
The secondparadigm, deriving fromCoase, has noneofthesedemonstrated
advantages.Notat thistime,anyway. The modernfoundation forthiscompeting
paradigm has onlyrecently beenconstructed, andanalysesdeveloping itscentral
themesand expandingits substantive scope are clearlyin theirearly,formative
stages;indeed,worksreverentially citedas classicsintheareaarebarelytenyears
old, if that.In contrast to thebehavioralparadigm,thisone remainsisolated
withineconomics,andquestionsof itsinterdisciplinary valuehaveonlyrecently
begunto be addressedin regardto areas, such as accounting(Jensen,1983;
Wilson, 1983), thatare close to beingpartof the disciplineitself.Virtually
nothinghas been done to exploreits value forissues of traditional interest to

750 M. Moe
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orsociologists,
politicalscientists andwhether itcan rivalthedemonstrated value
ofthebehavioral paradigmin thesedisciplinesis entirely uncertain.
The new economicsof organization, whileshapedin important waysby
Simon'sideas, is largelyfoundeduponthissecondparadigm.Amongits basic
elementsare thoseoutlinedabove:thecontractual natureof organizations, mar-
ketsvs. hierarchies,transactionscosts,therationality ofstructure, individualistic
explanation, andeconomicmethodsof analysis.Standardneoclassicalnotions-
optimization, marginality,equilibrium-areoftencentralto workin thisnew
tradition,andwriters tendto viewtheirefforts as "complementary to,ratherthan
a substitute for,conventional analysis" (Williamson,1975, p. 1). In general,
then,thiscontractual paradigmrepresents a less dramatic breakwithneoclassi-
cismthanthebehavioral paradigm, andmanyofitsadherents areconcerned with
seeingit integrated intothebroaderneoclassicalframework (or seeingthelatter
expandedto includeit). Nonetheless, itsinsistencethatfirmsbe viewedas orga-
nizationsand thatexplanation of economicoutcomesrequiresan underlying or-
ganizationtheoryis a definite,important departure fromthe mainstream-so
muchso thatit is unclearthatan integration withneoclassicism as we knowitis
evenpossible.
The renaissance of thecontractual paradigmis rootedin AlchianandDem-
setz (1972). Theyargue,as Coase did, thattheparticular organizational (con-
tractual)arrangement we identify withthecapitalistfirmis moreefficient than
alternativecontractual arrangements occurring purelywithinthemarket, andthat
theexistence offirmscan be derivedfroman analysisofrational behavior.While
theiranalysiscould be couchedin thegeneraltermsof transaction costs,they
focusmorenarrowly on the"shirking-information" problem,and theirclaimis
thatthefirmexistsbecause it providesa bettersolutionto thisproblemthan
markets do. A briefreviewof theirargument introduces a numberof important
concepts.
Alchianand Demsetznotethatforcomplexproduction processesthereis
typically a gain fromcooperation. Teamsof inputownerscan producemorein
cooperation withone another thanseparately, andthisgivestheman incentive to
coordinate theiractions.Yetteamproduction also suffersfroma peculiarproblem.
Preciselybecause of the complexinterdependence of tasksand theirfrequent
remoteness fromorganizational output,themarginalproducts of individualsare
difficultandperhapsimpossible todetermine; thus,intheabsenceofmechanisms
formonitoring eachindividual'sbehavior, theycannotrewardoneanother accord-
ing to individualimpactson output.Divisionof theteam's surplusamongits
members, then,mustproceedaccordingto someotherrule-equal sharing,for
example-thatdoes notdependuponknowingeach person'sproductive impact.
It happens,however, thatthis inducesa distinctive kindof reactivebehavior
amongthemembers themselves: shirking.
Each individual knowsthathiseffort has someimpacton theteam'sreward,
butthatthisrewardis splitamongall members; thus,whilehe bearsthefullcost
ofhiseffort, he receivesonlypartofwhathiseffort produces.On theotherhand,

whenhe shirksby reducinghis effort expenditures, thesavingsin effort accrue

onlyto him,and theresulting losses in teamrewardare bornelargelyby the
others.A fundamental asymmetry thereforecharacterizes thestructure of incen-
tives,andeach member willtendto finditin his ownbestinterests to engagein
somedegreeof shirking. Teamproduction andrewardsfallas a result,andeach
member mayactuallybe worseoffthanifno one had shirked fromtheoutset.
Whiletheymayrealizethattheircollectivefateis suboptimal, moreover,
thatwillnotin itselfallowthemto solvetheproblem: theyaretrappedin whatis
essentially a prisoner's dilemma.Theircooperative effortis plaguedby a public
goods problem(wherethepublicgood is theteamreward)thatpromotes free-
riderbehavior(shirking) amongmembers.The problemis a reflection of under-
lyingexternalities: foreach individual,thefactthatothersbenefitfromhis pro-
ductiveeffort is externalto his decisioncalculus,andhe therefore choosesmore
leisurethanis socially(fortheteam)desirable.
In viewofthis,howcan member shirking be reduced?AlchianandDemsetz
argue that the usual market mechanisms-e.g., allowingoutsidersto bid for
shirkers'placeson theteam-will notwork,sincebidderscannotknowwhothe
shirkers are and, worse,bidderswouldalso have incentives to shirkonce they
join theteam.On theotherhand,ifinformation couldsomehowbe gainedon the
marginalproductsof individualmembers,theycould agreeto be rewardedon
thisbasis, externalities wouldthereby be reduced,and everyone couldbe made
betteroffas a result.Thus,thewaytomitigate theshirking problem is tomonitor
theproductive effortsofteammembers. Ifmonitoring wereperfect, eachindivid-
ual's marginalproductcould be knownwithcertainty and shirking could be
completely eliminated. But,becausemonitoring is costly,thebesttheteamcan
do is to investin monitoring up to thepointwhereits marginalcostsbeginto
outweighthemarginalbenefits fromreducedshirking. Some degreeof residual
shirking is thusbothrationalandto be expected.
How can monitoring be carriedout mostefficiently? To avoid hierarchy,
memberscould rotatethejob of monitoramongthem;but thissacrificesthe
efficiencies of specialization.A better alternativeis to hirean outsider orappoint
a teammember tobe a full-timemonitor. Thisallowsforspecialization, butpoints
to stillanotherquestion:who will monitor themonitor? Because his marginal
productwill be unknown,he will also have an incentive to shirkand thusto
monitor less efficiently thanhe otherwisemight-whichimplies,in turn,that
membermarginalproductswill be measuredimproperly and memberresources
willbe misallocated.Giventhemonitor's uniquelycentralrole,thekeyto team
productivity is to ensurethathe has incentives to do hisjob efficiently. The best
wayto do this,AlchianandDemsetzargue,is togivehimmarketable titleto the
team'srewardsand establishhimas centralcontracting agentwithall itsmem-
bers.He wouldthenpay memberstheirestimated marginalproducts,based on
bilateralcontracts betweenhimandeachmember, andkeeptheremaining amount
as personalincome.This new statusclearlyenhanceshis incentives to monitor
efficiently.It also giveshimboththeincentive and theauthority to adjustpay-

752 M. Moe
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mentsin accordancewithobservedproductivity and to makechangesin team
membership in theinterests ofhigherteamrewards.Moreover, thisis an arrange-
mentthatall rationalteammembersshouldfavor,forit promisesto makethem
all betteroffby mitigating theshirking problem.The hierarchical relationship
thatresultsis notone of fiator dominance,buta contractual quid proquo into
whichtheyall voluntarily enterin pursuitof greater gain.
This mutualaccommodation, of course,is thecharacteristic organizational
formof theneoclassicalfirm,withthemonitor as entrepreneur. It emergesspon-
taneouslyfromthecontracting behaviorsof rationaleconomicactorswhenever
the netvalue of teamproduction (includingmonitoring costs) exceedsthenet
valueof thecorresponding bilateralmarket exchangesamongindependent input
owners.Undersuchconditions, economicorganization intheformofthebusiness
firmis theefficient production alternative.Thatis whyitexists.
Alchianand Demsetzthusgo well beyondCoase in demonstrating why
factorsoverlooked bytheneoclassicalmodelin factoperateto providea rational
foundation foreconomicorganization. Theirperspective has obviouspromisein
application to issuesoforganizational management andcontroland,indeed,to a
vastrangeof theoretical questionssurrounding thesuperior-subordinate relation
characteristicofall hierarchies. Fortheirlogicimpliesthathierarchy, monitoring,
incentives to shirk,and memberproductivity are integrally boundup withone
another.Thus,whiletheiranalysisis explicitly aboutfirms, itrestson theoretical
foundations thatcapturesomething inherent in organizational and hierarchic be-
haviorgenerally. It wouldappearthatthisbroadanalytical scope,combinedwith
theirimplicitacceptanceof theoptimization model,largelyexplainstheinterest
and enthusiasm theirarticlehas generated. Forthefirsttime,economists had a
theoreticalperspective thatrivaledthebehavioral paradigmin organizational rel-
evancewithout straying too farfromneoclassicalfoundations.
Subsequent workon theeconomicsoforganization testifies to thegenerality
andpromiseofthecontractual paradigm.Substantive attention no longerfocuses
on the classical firm,but addressesthe fullarrayof organizational topics.A
favoriteis verticalintegration, withattention to theconditions underwhichra-
tionalfirmswouldsubstitute nonmarket administrative relationships forcross-
firmmarket relationships by annexingotherorganizations operating at different
stagesofproduction ordistribution (Williamson,1975;Demsetz,1982). Another
is thesubstance oftheemployment relation-theinternal labormarket (Doeringer
andPiore,1971)-whereinvestigation includespayment systems (e.g., salaryvs.
wagesvs. piece rates),promotion systems(seniority vs. merit),unions,worker
qualifications, on-the-job learning, employer-worker bargaining, andothertopics
oftraditional interest (Spence,1975).
The one thathas stirred themostexcitement is theseparation of ownership
and control.A traditional topicof concernand controversy amongeconomists
(Berle and Means, 1932), it has now takenon specialinterest-for, in shifting
theAlchian-Demsetz logictotheupperreachesoforganization, newlightis shed
on therationality ofgoverning structures generally. In thecase ofthecorporation,

attention centerson whether its characteristic formof organization is efficient
relativeto marketand nonmarket alternatives. The corporateformallows for
decisionalspecializationand unrestricted risksharing,bothconduciveto effi-
ciencyin large-scaleenterprise, while,at thesametime,important mechanisms
are availableformitigating the shirking problemsinherent in the stockholder-
managerrelation.(1) The unrestricted sale and ownership of stockmeansthat
stockholders can pulltheirinvestment outwhenever management decisionsfailto
yieldprofits thatcomparefavorably to thoseof othercorporations. (2) Corpora-
tionswhosepotential forprofitgoes unrealizeddue to managerialshirking are
primetargets fortakeovers byotherorganizational management teams.(3) Stock-
holdersgenerally delegatemostcontrolandmonitoring functions to smallboards
ofdirectors, whichhavefarbetter information andresources formitigating shirk-
ing problems.Undera varietyof economicconditions, therefore, the modem
corporation emergesas an optimalorganizational form.Itallowsfundsfromlarge
numbers of unrelated,decisionally uninvolved investors to be productively em-
ployedby specialized,skilleddecision-makers, whiletheshirking problems that
otherwise threatenproductive efficiency are substantially mitigated (see Fama,
1980;FamaandJensen,1983a; Jensen andMeckling,1976).
By extension, thissamelogiccan be appliedtoothertypesoforganizations,
forthestockholder-manager relationis buta special case of themoregeneral
relationbetweenthosewhohavea "right"to controlan organization (ordinarily,
residualrisk-bearers) and thosedecision-makers (managers)who in factmake
mostof theimportant organizational decisions.As contributors to theliterature
arewellaware,current analysesofcorporate governance areimportant notsimply
forwhattheytellus aboutcorporations, butforwhattheyimplyforgovernance
in a widevariety of organizations (FamaandJensen,1983a, 1983b).
Workin thistradition also reflects a shiftin theoretical focusfromAlchian
and Demsetz,due in partto criticismof basic pointsof theirargument: that
production processesare nottrulyinseparable,thatthecauses of shirking are
moregeneralthantheiranalysisof teamsimplies,and thatfactorsotherthan
shirking are also centralto therationality of organization. Probablythe most
comprehensive alternativetotheAlchian-Demsetz logicis developedbyWilliam-
son in Marketsand Hierarchies(1975), wherean explicitattempt is made to
integratemajorcomponents fromthecontractual andbehavioral paradigms.Wil-
liamsonarguesthattherelativeefficiency oforganization arisesfromthejoining
of uncertainty and smallnumbers (environmental factors)withopportunism and
boundedrationality (humanfactors).Uncertainty combineswithboundedration-
alityto limitrelianceon long-term contracting-which wouldrequirespecifica-
tion of complexfuturecontingencies-andto encouragethe substitution of
internal organization, whereuncertainty can be absorbedthroughadaptation,
learning, sequentialchoice,andrelatedmechanisms in theSimontradition. Sim-
ilarly,small numberscombinewithopportunism to limitrelianceon frequent
short-term contracting.If an economicagentrelieson themarketin contracting
andrecontracting forthemyriad servicesneededforproduction, service-suppliers

754 M. Moe
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gain specializedknowledgeand skillsthrough theirperformance of thesetasks
andbecomefarbetter qualifiedthanothersinthemarket. In subsequent contract-
ingsituations, then,large-numbers exchangetendsto be transformed intosmall-
numbersexchangein whichthe moderating effectsof marketcompetition are
largelyabsentand, due to opportunism, service-suppliers will use "information
impactedness" to theirown advantagein exactingconcessions.The wayto get
aroundthisis to avoidengagingin frequent short-term contracting, producing
insteadbymeansofan organizational arrangement. Givenappropriate rewardand
monitoring structures, transaction costscan be reducedsubstantially.
YetWilliamson'sframework is notbyanymeansstandard. To theextent that
thisliterature has a commontheoretical emphasis,it is insteadon moregeneral
aspectsofthecontractual relation:incomplete information, especiallywhenasym-
metrically distributed acrossthecontracting parties,and conflictof interest. To-
gether, theseoffer a moregeneralexplanation oftheshirking-information problem
thatis nottiedto teamsor production inseparabilities. Theyalso providea more
powerful framework fortheanalysisof hierarchical relationships, one withclear
linksto information economics,gametheory, andotherareasof thediscipline.
Twoconceptsat theheartofthisframework are adverseselectionandmoral
hazard.Bothemergedfromearlyappliedworkon insuranceand wereincorpo-
ratedintothemodemworkon information andorganization inrecognition oftheir
muchbroadertheoretical significance. Adverseselectionderivesfromunobserv-
abilityof theinformation, beliefs,and valueson whichthedecisionsof others
arebased. Consideran examplefromtheemployment relation,in whichan em-
ployerseeksapplicantsfora marketing researchpositionrequiring independent,
creativework.While he would like to attracthighlyqualifiedand motivated
individuals, he cannotknowanygivenapplicant'strueintelligence, aptitude,or
work habits. What he can do is to proceed on the basis of rough indicators, like
thus his
educationorjob background, declaring willingness pay to a certain price
forindividualswho are nominally qualifiedaccordingto theseindicators; the
priceis in effecta statistical average,reflecting boththeestimatedimplications
oftheindicators forproductivity andtheestimated variation inproductivity across
all individualswho qualify.The individualevaluatingthisprice,on the other
hand,does knowhis ownqualifications and workhabits.If he is in facthighly
creative,andmotivated,
intelligent, he willtendtofindthattheemployer's proxy-
based priceunderstates his trueeconomicvalue; while,if he is in factquite
lackingin all thesedesirabletraitsbutstillmeetstheformal proxyrequirements,
he will tendto findthatthepriceoverstates his trueeconomicvalue. The latter
typeofindividual is thuslikelytoviewthejob as an opportunity, whiletheformer
is likelyto lookelsewhere-especially for"better"jobs whoseproxycategories
are eithermorefinelymeasuredor simplypitchedat a higherlevel.In addition
to all this,individualswho happento place highvalue on leisureare likelyto
findthisjob particularly appealing,becausesupervision is minimaland produc-
tivityis difficult to measure;high-productivity individuals, in contrast, will find

themeasurement problem a negative factor,sincetheywanttheirtrueproductivity

to be observedandrewarded.
Becausetheemployer cannotin generalknowthesethingsaboutapplicants
(i.e., each applicant'strue"type"), whereastheapplicantsthemselves clearly
do, hisrecruitment effortwilltendto suffer fromadverseselection:he willattract
a disproportionate numberof low-quality applicants.Moreover, eventhoughhe
and thebestof theseapplicantssharea commoninterest-hewantsto hirethe
best,thebestwantstobe hired-thismaynotease hisproblem, fortheasymmetry
remains.He cannotknowforsurewhichapplicantis trulythebest,andthebest
applicantcannotcrediblyclaimthathe is in factsuperbly qualifiedbecauseall
individuals haveincentives to makethesame sortsof claimsin orderto getthe
job.
Moralhazardarisesfromtheunobservability of actualbehaviorin theex
postcontracting situation-here, afteran applicant beenhired.The employer
has
for
cannotknow sureto what extent theindividual is productive andinsteadmust
ordinarily relyuponproxies-e.g., qualityofreports, timeliness,diligence.The
individual thenhas an incentive to redirecthisefforts towardtheproxymeasures
(a phenomenon calledgoal displacement in thesociologyoforganizations) rather
thantheabstractgoals implicitin theemployment contract; and he also has an
incentive to substitute leisureforproductive effort, sincetheunobservability of
hismarginal product allowshimtoachievethesebenefits atlowcost(theexpected
costofbeingdetected).Shirking behavior,therefore, is an aspectofmoralhazard,
withtheincentive to shirkderiving fromunderlying information asymmetries.
Moralhazardand adverseselectionaregeneralproblems whosepotential is
inherent in all contracting andhierarchical relationships. As theoreticalconcepts,
theyare particularly valuableforunderstanding situationsin whichone party
seeks to controlthebehaviorof another, or,moregenerally, to achievecertain
outcomes(suchas profits) byrelyingon andstructuring thebehaviorof various
otheractors.These,ofcourse,aretheessenceoforganizational analysis,whether
the substancehas to do withdecentralization, divisionof labor,formalrules,
structure,communication, or ownership vs. control:all are reflections of efforts
to controltheproductive efforts of organization members-andall, because of
information asymmetries, are shapedbymoralhazardandadverseselection.
Considerwhathappens,forinstance, whenorganizations decentralize. Tasks
and authority are delegatedto lower-level unitsin theexpectation thattheywill
use theirspecializedknowledgeand productive capacitiesto contribute toward
organizational ends;buttheinevitable information asymmetries createincentive
problems. An upper-level unitsolicitingpolicyinputsfromlower-level unitswill
pay thepriceof adverseselection,sinceonlythelower-level unitsknowwhat
information theirinputsare based upon, and theycan use thatto theirown
advantage;similarly, a superior unittrying to increasea subordinate unit'spro-
ductiveefficiency will haveto grapplewiththeproblemof moralhazard,since
theobservability of productive behavioris asymmetrically distributedin thelat-
ter'sfavor.To takeanother example,considertherelationship betweenstockhold-

756 M. Moe
Terry
ers and managers.This is a variation on thesame theme:stockholders wantto
controlmanagers intheinterests ofprofits,butmanagers tendtopossessfarbetter
information bothaboutactualorganizational behavior(includingtheirown) and
aboutthetechnical andcognitive groundson whichproposalsareformulated and
adopted-leading,once again,to moralhazardand adverseselectionproblems
forstockholder controlefforts.
Acrosstheseandotherorganizational areas,therefore, theeconomicanalysis
oforganizations tendsto centeron questionshavingto do withtheincidenceand
content of information asymmetry, whytheasymmetry exists,whatitimpliesfor
contractual outcomes,and howtheasymmetry or itsconsequencescan be miti-
gated.Theoretical inquiryintothesequestionstakesdiverseforms,butone ana-
lyticalframework is so eminently well suitedto thetaskthatit has becomethe
dominantframework forthe formalanalysisof hierarchy: the principal-agent
model.This modelwas initially developedto investigate moregeneralquestions
of incomplete information andrisksharing(Ross, 1973; SpenceandZeckhauser,
1971), notto spurthedevelopment of organization theory, and it has becomea
majoranalyticaltoolin thegeneralliterature on information economics.Butits
relevanceforexplicitly organizational analysiswas quicklyrecognized,and ap-
plicationsto the centralissues of organizational theoryare growing(Jensen,
1983).
The principal-agent modelis an analyticexpression of theagencyrelation-
ship,inwhichoneparty, theprincipal,considers entering intoa contractual agree-
mentwithanother, theagent,in theexpectation thattheagentwill subsequently
choose actionsthatproduceoutcomesdesiredby the principal.Examplesof
agencyrelationships arelegion:lawyer-client, doctor-patient, broker-investor, pol-
itician-citizen,
and,mostgenerally, employee-employer. As theseexamplestend
to suggest,a principalmayseekoutan agentforvariousreasons.Oftenhe may
lack specializedknowledgeor legal certification thattheagentpossesses,and
sometimes thesize or complexity of thetasksimplyrequirescoordinated action
bypersonsotherthanhimself.Butgivensomemotivation forrelying on an agent,
theprincipal's decisionproblem is farmoreinvolvedthansimplylocatinga qual-
ifiedperson-forthereis no guaranteethattheagent,once hired,will in fact
chooseto pursuetheprincipal'sbestinterests or to do so efficiently. The agent
has his owninterests at heart,andis inducedto pursuetheprincipal'sobjectives
onlyto theextentthattheincentive structure imposedin theircontract renders
suchbehavioradvantageous.
The essenceoftheprincipal'sproblem is thedesignofjustsuchan incentive
structure.The difficulty, of course,is thatinformation abouttheagent'sactions
andtheinputson whichtheyarebased is notonlyimperfect butskewedin favor
of the agent,yieldingadverseselectionand moralhazardproblemsthatmust
somehow be mitigated. Thedesignofan efficient incentive structure is thusbound
up withthedevelopment ofmonitoring systems as wellas mechanisms forinduc-
ingtheagentto revealas muchofhisprivately heldinformation as possible.The
principalmustweavetheseinterrelated components intoa contractual framework

that,in mitigating the informationalasymmetries and structuring rewards,

prompts theagentto behaveas theprincipalhimselfwouldunderwhatever con-
ditionsmightprevail.
The logic of theprincipal-agent
model,therefore,
immediately leads us to
thetheoretical issuesat theheartofthecontractual
paradigm:issuesof hierarch-
ical controlin thecontext of information
asymmetry andconflictofinterest. It is
a naturalframework fortheeconomicanalysisof organizations
of all kinds,and
adherents areenthusiastic aboutitspromise.
The problemof inducingan "agent" to behaveas if he weremaximizing the"principal's"
welfareis quitegeneral.It existsin all organizations
and in all cooperative
efforts.... The
development of theoriesto explaintheformwhichagencycoststake. . . and howand why
theyare bom will lead to a richtheory of organizations
whichis nowlackingin economics
andthesocial sciencesgenerally. (Jensen andMeckling,1976,p. 309)
The advantage ofa simpleanalytical framework is thatorganizational issues

can be castin a clear,rigorousmannerthatallowsfortheapplication ofconven-
tionaleconomicmethods.A corresponding disadvantage, however, is thatsucha
framework sometimes encourages highlycomplexmathematical treatmentoftriv-
ial problems; formtendsto triumph oversubstance,andanalytical concernstend
totakeon livesoftheirownthathavelittletodo withtheexplanation ofempirical
phenomena.
Theprincipal-agent literaturereflects
boththesepositiveandnegativeforces.
It has clearlyenhancedourunderstanding of hierarchical relationshipsand rep-
resentsa majoradvancebeyondtheusual sociologicalmethodsoforganizational
analysis.In partthisis duetoimportant theoreticalconclusions-regarding, e.g.,
incentive mechanisms forrevealing an agent's"type" (Myerson,1979),therole
of signalingand screening devices(Spence, 1974), conditions fortheoptimality
of alternative rewardsystems(Shavell,1979; Holstrom,1979) and monitoring
and accounting systems(Baiman,1982), amongothers.Butit is also due to its
demonstrated valueinclarifying whattherelevant aspectsofhierarchical relation-
shipsare. It cutsthrough theinherent of
complexity organizational relationships
byidentifying distinctaspectsofindividuals andtheirenvironments thataremost
worthy of investigation,and it integrates
theseelements intoa logicallycoherent
whole.
On the negativeside, however, muchof the current literaturefocuseson
matters oflittlesubstantive interest;"authorsareled to assumetheproblem away
or to definesterile'toy' problemsthatare mathematically tractable"(Jensen,
1983,p. 333). Inherent substantive complexity is magnified ratherthansimplified
bymanyoftheseefforts, andanalytical progress oftenhaslittletodo witharriving
at betterexplanations of trulyinterestingtypesof organizational behavior.The
realdanger, criticswouldargue,is thattheeconomicsoforganization willgo the
wayof mainstream neoclassicism, withanalyticsand methodsdominating sub-
stance.This wouldbe theultimateirony-forthisnewarea began,afterall, as
an efforttoputrealismandsubstantive relevance backintomicroeconomic theory.

758 M. Moe
Terry
Yetthereare impressive influences.
counterbalancing Centralfiguresin the
economicsoforganization-Simon, Williamson,Alchian,Demsetz,Jensen, and
others-are strongly committed to the development of analyticalframeworks
firmly anchoredinthesubstance oforganizations.The behavioralparadigm itself
is anotherimportant factor;itsemphasison adaptation,
learning,search,andother
empirical aspectsofdynamic processesareforceful
organizational reminders that
static,dyadic(as mostare) principal-agent modelsassumeawaymuchof whata
comprehensive theory oforganizationalbehaviormustultimately accountfor.And
finally,thereis theimposingrealityoforganizations: hierarchicsystemsofinter-
dependent participantswhosejoint,time-dependent behaviorappearsto be well
beyondthecapacityofsimplerational modelstoexplain,atleastinmostrespects.
The disappointing performance ofN-persongametheory, aftermuchearlyexcite-
ment,is buta case in point.
In all likelihood,thecontractual paradigmwill continueto dominateeco-
nomicapproachesto organization, owingto itslinkagesto neoclassicism.Butit
will also continueto includediverseapproaches,somefarmoreconcerned than
otherswiththeempiricalrichnessof organization. The principal-agent model,
ideallysuitedto theanalysisof hierarchical is understandably
relationships, the
majormeansof formalmodelingat presentand shouldbecomewellestablished
as an important tool of organizational
analysis.Giventhecountervailing influ-
ences,however, and giventhebroadertasksof organization theory,thecurrent
fervor surrounding theprincipal-agentmodelwilllikelygivewayto a moreeclec-
tic methodology withinwhichthatmodelplaysa less pronounced but integral
role.
Applicationsto Public Bureaucracy
That thisframework mightbe an important tool forpoliticaland social
analysismoregenerally was recognizedfromthebeginning by Mitnick(1973,
1980). ButMitnick'sarguments attractedlittleattention,andtothisdaythereare
veryfewapplications of organizationaleconomicsto publicbureaucracy, or to
any area of politicsforthatmatter.New workalong theselines is onlynow
emerging (Weingast,1983; Kalt, 1981; Kalt and Zupan,forthcoming [1984]), a
spillovereffectof its demonstrated analyticalpowerand growingpopularity
withineconomics.Conditions are ripe,however, and it is onlya matterof time
beforepoliticsbecomesthecontractual paradigm'snewfrontier.
Mypurposeinthissectionis tosuggestsomeofthebasicelements thatcome
intoplaywhenthisframework is appliedtopublicbureaucracy-and toemphasize
thatthetransitionfromeconomicstopoliticsis byno meansstraightforward. The
discussionis usefullystructuredaroundthreequestionsto whichthecontractual
paradigmclearlymustassigncentralimportance. (1) Whydo publicbureaus
exist,as opposedto alternative
arrangements fortheprovision ofpublicservices?
(2) How can bureaucraticsuperiorscontrol bureaucratic subordinates?(3) How
can politicians,
as principals,
controltheirbureaucratic agents?

WhyDoes PublicBureaucracy
Exist?
The neweconomicsof organization engagesin a familiar kindof reasoning
associatedwiththesocial contract in politicaltheory.
theorists Reference is to a
stateofnaturecomprised ofautonomous decision-makers, andquestionsconcern
thekindsofsocialagreements atwhichtheseindividuals wouldvoluntarily arrive.
In theeconomicanalogy,thestateof natureis characterized by a freemarket
populatedby economicagents.As Williamson(1981, p. 1547) putsit, "in the
beginning, so to speak,thereweremarkets."Rationalbehaviorthenleads to
varioussortsof contractual arrangements, some of whichassumewell known
productive forms:thefirm,the moderncorporation, etc. These formsemerge
because,giventransaction costs,monitoring costs,and otherobstaclesto coop-
erativeexchange,rationalactorsfindthemmoreefficient thanmarkets or alter-
nativeorganizational arrangements.
Supposewe go alongwiththislineof inquiryand exploreits implications
fortheexistenceof publicbureaucracy. Could it be, as theconventional logic
seemstoimply, thatpublicorganizations also existbecausetheyaremoreefficient
thanthealternatives? Forstarters, we can onlyrecognizethatthestate-of-nature
argument is morethana littlestrained forpublicbureaus.Williamson'spremise
mustbe turned on itshead:in thebeginning, theretypicallly wereno markets for
sectorservices.Economists
public, havelongpointedtothesupplyofpublicgoods
as a majorjustification fortheexistenceof government anditspowerto tax-but
theproblem thatpublicgoodspose, ofcourse,is thefailureof markets. Citizens
haveinadequateincentives to revealtheirtruedemandand to contribute accord-
ingly,and potential suppliershaveinadequateincentives to produce.A solution
is forthegovernment to act as thecitizens'agent:it arrangesfortheoptimal
supplyof thepublicgood and taxeseach individual accordingto thebenefits he
receives.Yethowdoes it arrangein theabsenceof an availablemarket? There
are twobasic possibilities: itcan createitsownbureaucracy, or itcan engagein
marketlike transactions bycontracting withprivateactorswhopromisetoprovide
servicesat a stipulated price(thereis no prevailing market price)to be paid by
thegovernment. The latter optionwillrequirethatproducers moveintonewareas
of activityor thatneworganizations be created,perhapswithgovernmental as-
sistance.
The contractual paradigmsuggests,amongotherthings,thatgovernment is
morelikelyto prefertheprivatecontracting methodwhencontractor "types"
(reputations, expertise, honesty) arewellknown,serviceoutputs areeasilymeas-
ured,andnegotiations arenotplaguedbythesmall-numbers problem. Knowledge
of contractor type is necessaryto minimizeproblemsof adverseselection,
whereby thegovernment is in dangerof attracting inefficientor unreliable candi-
dates;measurability and therefore monitoring are important ifthegovernment is
to minimizemoralhazard-clearlya distinct possibility
withprofit-maximizing
producers whocankeepwhatever is notpaidouttothegovernment, andwhomay
even be reimbursed forunnecessary expenditures and actionsthatwerenever
taken;and smallnumberspointsto a situation in whichthegovernment is ulti-

760 M. Moe
Terry
matelyboxedintonegotiation withoneora fewcontractors, who,especiallyafter
someinitialperiodofperformance, haveknowledge andskillsso specializedthat
theybecome"irreplaceable"and are in a positionto reapnear-monopoly gains
through hardbargaining.
A standardexampleof a publicservicewell suitedforprivatesupplyis
garbagecollection.Refusecompaniesarerelatively inexpensive tooperate,allow-
ingthegovernment toemployseveralat onceindifferent areasofa cityorto shift
fromone to another(or threaten to). This elementof potential competition pro-
videsinformation overtimeon company"types,"anditundermines thethreat of
small-numbers bargaining. Moreover, becauseperformance is easilyobservedand
evaluated,shirking can be controlled reasonably well withoutsubstantial moni-
toring costs.Forall thesereasonsa citygovernment mayfinditquiteefficient to
contract outforrefusecollectionservices.
Whentheseconditionsare notmet,however, thegovernment mayfindit
moreefficient to internalizecontractingrelationships by settingup its own bu-
reaucracy.Considertheprovision ofpoliceservices.Adverseselectionis a severe
problemhere,sincethejob of policeofficeris unfortunately likelyto appeal to
manypeoplemoreinterested in powerandphysicalcombat(and,in theold days,
graft)than"keepingthepeace"; efficient performance requirescandidateswith
sensitive
judgment and well-developed interpersonal skills,qualitiesthatare dif-
ficultto observeat thehiringstage-particularly if someoneelse is doingthe
hiring.Behavioraloutputsare also difficult to observe,in partbecause it is
unclearprecisely whattheoperative goalsofa policedepartment oughtto be and
how theirachievement can be measured.Whilea contract mayeasilystipulate
proxycriteria (e.g, number ofhoursofpolicepatrol),specifying "amicablerace
relations"or "effective crimedeterrence" is farmoreproblematic, as is perform-
ance evaluationon thosebases-leading to seriousmoralhazardproblems.Fi-
nally,shoulda towndecideto use themarketlike mechanism of contracting for
police serviceswitha largermunicipality or county,it facesa small-numbers
bind:thesole suppliercan use itsmonopoly positionto inflatepriceand reduce
quality.All of theseare arguments forestablishing a publicbureaucracy forthe
provisionof police services.Adverseselectioncan be controlled via personnel
departments or,better, byuse ofpoliceacademiesthatscreen,train,andevaluate
policerecruits. Behavioraloutputs,whilestilldifficult to observe,can be moni-
toredfarmorecloselyby insiders;and, if desired,special mechanisms can be
adopted-civilianreviewboards,internal affairsdivisions-tointroduce different
typesor stillgreaterdegreesof outputsurveillance. Thus theasymmetries that
promotemoralhazardcan be attackedmoredirectly.And the small-numbers
problemis reducedby shifting froman outsidesole supplierto insiderswhose
jobs, pay,promotion, and careersare to someextentsubjectto hierarchical con-
trol,and whoseincentives and opportunities to bargainas internal monopolists
are shapedaccordingly.
In manycases, however, bureaucracy and contracting out are notdramati-
callydifferent organizationalarrangements in practice.This is becausecontract-

ing typicallyinvolvessubstantial elementsof hierarchy and monitoring. Most

federalcontracting, forinstance,takesplace in thearea of defense;and theDe-
partment of Defenseis continuously involvedin ratifying and directing thedeci-
sionsof defensecontractors, observingtheirproductive efforts, and evaluating
outputs.Such is theinvolvement, in fact,thatcriticsclaimdefensecontractors
areeffectively an integral partoftheDepartment's bureaucracy (Melman,1970).
Thisis a familiar exampleof "close" government-contractor relationships,butit
is hardlyunusual-and is preciselythekindof thingthecontractual paradigm
wouldlead us to expect.All principal-agent relationships containwithinthem
characteristic "agencyproblems,"restingon information asymmetries and con-
flictof interest, and it is generallyrationalfortheprincipalto mitigatethese
problems through hierarchical controlsand monitoring. Dependingon thenature
and severity of the problems,thismayentailsettingup a new publicorgani-
zation,delegating tasksto a privatecontractor withvirtually no stringsattached,
orany"mixed" typeof contractual arrangement betweenthetwopoles. It is not
a dichotomous choice,buta matter of balance.
This perspective on publicbureacracy helpsto structure ourthinking about
therelativeefficiency of alternativeorganizational arrangements. Yet we must
remember thatthecontractual paradigmhas been developedwithreference to
privateorganizations, particularlybusinessfirms,and thatsomeof itsmostfun-
damentalcomponents mustbe modifiedif itsapplication to publicorganizations
is to be meaningful and instructive.Barringthis,straightforward applicationof
the paradigmcould be seriouslymisleading.Considerthe following pointsof
departure.
1. Politiciansare thedecision-makers withauthority to determine whether
publicbureauswillbe established to delivergovernmental services,and,in gen-
eral,howthesebureauswillbe structured. Theyplaytheentrepreneurial role.Yet
politiciansare not primarily motivated by productive efficiency or the public
interest inmakingsuchdecisions.Mostobviously, electoralconsiderations prompt
concernforconstituency service,pleasinginterestgroups,rewarding contributors,
avoidingconflict,takingsymbolicstands,and claimingcreditforpopularout-
comes(Mayhew,1974; Fiorina,1974, 1977). This meansthat,whenpoliticians
choose betweenpublicbureaucracy and contracting out, theyare generally not
choosingon efficiency grounds-norarethey,in theconventional sense,seeking
an optimally balancedsetof hierarchical controlsandmonitoring mechanisms in
designing thedetailsofthecontractual arrangement. A contractor maybe chosen
because he is a majorcontributor to a subcommittee chairman'scampaign;a
bureaumay be createdbecause it opens opportunities forpatronage;and the
controlstructure mayhaveless todo withthedirection ofpolicythanthefunnel-
ingof expenditures to legislative
districts.We wouldtherefore be quitewrongto
concludethatpublicbureaucracy exists"because it is efficient" without quali-
fyingwhatwe meanby "efficient."It existsand takespeculiarstructural forms
becauseit conducesto thewell-being of critically
locatedpoliticians.It maybe
an efficient organizational arrangement fromtheirstandpoint, butnotnecessarily

762 M. Moe
Terry
fromanyoneelse's-unless, of course,thereis something like a hiddenhand
operating to guarantee that,in pursuing theirown self-interest, thesepoliticians
areunintentionally maximizing social welfareas a by-product.
2. Unliketheprivatesector,wheretheargument is at leastplausible,there
is no hiddenhandto guarantee optimality forthepublicsector.On thedemand
side,commoncriticisms havetodo withthewaysin whichelectoralandpolitical
institutionsdistorttheunderlying distribution of citizenpreferences, promoting
fragmentation, parochialism, andcooptation by specialinterests rather thancon-
cernforthegeneralsocial welfare(see, e.g., Lowi, 1969; McConnell,1966;
Schattschneider, 1960;ShepsleandWeingast,1981). Thesefamiliar problems are
compounded by a fundamental flawon thesupplyside: servicesuppliersin the
publicsectorare notsubjectto forcesof naturalselectionbased on economic
efficiency.Undera market system,producers whofailto operateefficiently tend
to be weededout;theyare underbid in productmarkets, cannotattract fundsin
capitalmarkets, and ultimately cannotsurvive.The assertion thatfirmsandcor-
porationsare in factmoreefficient thanproduction alternatives is rendered far
moreplausiblebythisnaturalselectionmechanism foreliminating theinefficient.
Butsucha mechanism clearlydoes notoperateforpublicbureaus.Bureaussur-
viveby securingpoliticalsupport-from congressmen in committees, theinsti-
tutionalizedpresidency,interestgroups-sufficientto veto life-threatening
legislationby enemies;and theyexpandthescope of theiractivities by building
on thisbase of politicalsupport.Naturalselectionclearlyhas something to do
witha bureau's"politicalefficiency." Yetthiscriterion forselectionis notonly
consistent withproductive inefficiency, it oftentendsto cause it. Moreover, this
is a weak mechanismforactuallyweedingbureausout of thepopulation,for,
particularlyin theAmericanseparation of powerssystem,theminimum levelof
supportis rather easilyachieved;bureauscan be quitebad at garnering political
supportand nonethelesssurvive.Newer,"better" organizational formsmay
emergein thepublicsector,buttheygenerally do notreplacetheolderones;they
simplymakean undisciplined organizational population evenmorediverse.
In short,thecontractual paradigmcan onlyprovidea meaningful answerto
thequestion"Whydo publicbureausexist?"withconsiderable translation. As a
generalframework it offersa refreshing wayof thinking abouttheemergence,
survival,and relativeefficiency of publicorganizations, and clearlyhas theca-
pacityto generatea rangeof newideas and directions forinquiry. The studyof
publicbureaucracy couldcertainly use thiskindof invigoration. Butevena brief
discussionmakesplainthatthetranslation fromeconomicstopoliticswillnotbe
a simplematter. It willrequirea good deal oftheoretical innovation, backedbya
recognition thatthe modelsand conclusionsof organizational economicsmay
haveto be modified substantially.
HowCan Bureaucratic
SuperiorsControlTheirSubordinates?
Hierarchical
controlis facilitated
by a numberof interrelated
mechanisms,
amongthemostimportantofwhichis the"residual."In AlchianandDemsetz's

analysisof teams,theentrepreneur is givenmarketable titleto theresidualin
ordertoinducehimtomonitor teammembers efficiently;he hasmaximalinterest
in properly measuring member productivity-and in increasing itthrough hiring,
firing,and reorganization-because theoutcomesof memberefforts accrueto
him alone. Similarly, the moregeneralprincipal-agent modelsof hierarchical
controlhave shownthat,undera rangeof conditions,the principal'soptimal
incentive structurefortheagentis one in whichthelatterreceivessomeshareof
the residualin payment forhis efforts, thusgivinghim a directstakein the
outcome(e.g., Shavell,1979).
Forpublicbureaucracy, however, thereis no residualin theordinary sense
of theterm.The typicalbureaureceivesa budgetfromgovernmental superiors
andspendsall ofitsupplying servicesto a nonpaying clientele.Regardlessofthe
agency'sperformance or howit changesovertime,theresultsare notreflected
in an economicsurplusaccruingto bureauheads,andthismajorincentive forthe
efficientmonitoring of employeebehaviorfailsto operate.Incentiveplansthat
giveemployeesa shareof the"profit"in partialpayment fortheireffort (e.g.,
in locatingwelfarefraudor costoverruns) are also ruledout. The absenceof a
residualand its implications forinternal efficiency,therefore, wouldseemto be
factors thatimmediately setpublicbureaucracy apartfromprivateorganizations
andshapeourexpectations abouttheirrelativeperformance.
But is thereanyquantity thatmightplayessentially the same role as the
residual?The obviouscandidateis slack,thedifference betweenthetruemini-
mumcostof serviceprovision and whatthebureauactuallyspends(thebudget).
It has been arguedthatbureauheadsare indeedmotivated by slack,for,just as
Cyertand March(1963) pointedout forthe firm,it represents a cushionof
resourcesavailablefortheleader'spersonalconsumption or for"payoffs"(per-
quisites,leisure,newequipment) to alliesfortheirpolicysupport orsubordinates
fortheircompliance(MigueandBalanger,1974;Niskanen,1975). Liketheeco-
nomicresidual,then,it clearlycan be used forpurposesof internal bureaucratic
control.It also givesthebureauheadan incentive to monitor memberbehavior
andtoencourageefficient workeffort, becausehe is thenin a positionto capture
thedifference betweenthebudgetandtruecost;thisis howhe can actto increase
his storehouse of slackresources,andthushis verycapacityforcontrol.
The crucialdifference is thatslack is onlyavailableto theextentthatthe
bureauas a wholeoperatesinefficiently by producing at greaterthanminimum
cost,withbudgetexceedingthetruecostsofproduction. The greaterthisineffi-
ciency, thegreater theslack.Whenslackis a controlmechanism, then,efficiency
andinefficiency curiously coexist.In fact,theyfeedon one another.
Considerthecase of a subordinate who chooseson his own to shirk.In
doingso, he is soakingup slackresourcesthatcouldbe capturedandultimately
disbursedby thebureauhead. The lattertherefore has an incentive to employ
monitoring and othermethodsto eliminate"illicit" shirking, and thisin turn
encourages efficiency.Yetthebureauas a wholeremainsinefficient, fortheslack
has simplybeentransferred fromtheformer shirker to thebureauhead,whohas

764 Terry
M. Moe
no intentionof turning it back to his politicalsuperiors (by acceptinga smaller
budget)and who is now in a positionto applyit towardbureaucratic control-
e.g., bypermitting a compliant subordinate to engagein "legitimate"shirking.
Efficiency makesinefficiency possible,andinefficiency is tradedforcontrol.
In short,slackis nota functional substitute fortheeconomicresidual.If it
does in factmotivate bureaucrats-anditprobably does, to someextent-thenit
emergesas a mechanism withitsowndistinctive consequencesforbureaucratic
efficiencyand control,consequenceswhichagain underline thedifferences be-
tweenpublicandprivateorganizations.
Thereare stillotherimportant differences whenwe considermotivational
structure moregenerally. It is onlyreasonableto suggestthatpecuniary gain-
salaries,profits,fringebenefits-isfarmoresalienta motivator fortop-level
managersin theprivatesectorthanfortop-level bureaucrats in thepublicsector.
Politicaltheoriesof bureaucratic behaviorhavetended,quiteplausibly, to focus
onbudgets,slack,policy,careeropportunities, andsecurity as centralmotivators,
and theyhaverecognizedthatthesalienceof specificmotivators variesacross
bureaucratic officialsand withthenatureof the appointment (Downs, 1967).
Politicalappointees,mostobviously, aremorelikelyto be concerned withpolicy
and itsconsistency withthecurrent administration thancareerofficialsare. Per-
sonal incomeis of coursean important consideration forall bureaucrats, but
financialrewardsandopportunities aremuchmorelimitedandrigidlystructured
in government, and theyare muchless contingent upon individualproductive
effortor bureaucraticoutcomes.
Whatdoes thisexpandedsetof motivators suggestforinternal bureaucratic
control?Aboveall, it impliesthatdifferent "types" of bureaucrats will exercise
controltowarddifferent ends,depending on whichmotivational elements happen
tobe salientfortheir"type." Thereis no reasontothinkthatpoliticalappointees
will exercisecontrolin thesame wayas careerofficials,northatbudget-maxi-
mizerswill exercisecontrolin thesame waysas thosemotivated by policyor
slack.The emphasison efficiency, thekindanddegreeofmonitoring, themanip-
ulationof incentives-allwill dependon preciselywhata bureaucratic superior
wantsfromhis subordinates. Because thismaybe verydifferent fromtheobjec-
tivesofthetypicalmanagerial superior ina businessfirm,thehierarchical control
mechanisms surrounding publicmanagement willtendtobe correspondingly dif-
ferent fromthosein privatemanagement.
Theywillalso be different becausepublicmanagers, whatever theirpersonal
goals, mustoperatewithinan organizational contextwhosestructure and objec-
tivesare in important respectsimposedby outsideactors.The Civil Service
system, forinstance,imposesrulesforhiring, payandfringes,
firing, promotion,
andtheprocessing ofgrievances. Theseelements ofstructure condition thekinds
of individuals to
attracted bureaucratic jobs (the adverse selection problem)and
theiropportunitiesandincentives to shirkoncehired(themoralhazardproblem).
Although todemonstrate
difficult empirically, itis oftenarguedthattheseimpacts
are theoppositeof whatproductive efficiency wouldrequire:theytendto attract

and retainindividuals who are of lesserquality,overlyconcerned withsecurity,
andnotdisposedtoinnovate, andtheytendtoenlargetheopportunities forshirk-
ing whileminimizing therewardsof productive effort. Notcoincidentally, they
also place severeconstraints on theabilityof publicmanagersto do whatthe
contractual paradigm impliestheyoughttobe doingintheinterests ofhierarchical
control:screening and selectingappropriate personnel, weedingouttheinappro-
priate,anddesigning incentivestructuresthatconduceto maximalcompliance.
AndCivil Serviceis onlythebeginning. The Administrative Procedure Act
circumscribes the structuresand processesof administrative decisionmaking,
removing crucialcomponents oforganizational designandcontrol fromtherealm
ofchoice.The Freedomof Information Actrequiresthatagencyfilesbe opento
thepublicupon demand,implicitly encouraging bureaucrats to constraintheir
internal communications andstorageofinformation. Agency-specific statutesdic-
tatebureaucratic goals, imposeinternalstructures, requirereorganization, set
resourcelevels,and determine typesand numbersof personnel.The listcould
easilygo on.
In principlethesesortsofconstraints aresmoothly handledbythecontractual
paradigm;indeed,itsperspective on hierarchical controltellsus whatcontextual
elementsare likelyto be constraining. Yet actual analysesin the contractual
tradition have notemphasizedthisaspectof thecontrolproblem.Alchianand
Demsetz'sentrepreneur has virtuallya freehandin designing incentive structures
and monitoring systems,as does theprincipalin mostprincipal-agent models.
Thisis reasonableunderthecircumstances; theoreticaldevelopment is stillin its
earlystages,and it is necessaryto understand thefulldimensions oftheoptimi-
zationproblembeforeshifting attention to specificconstraints thatvarywith
substantive context.Nevertheless, thereare good reasonsforthinking thatbu-
reaucratic controlis muchdifferent forthepublicsectorthantheprivatesector,
andthata straightforward ofcontractual
application theories andtheirimplications
is likelytobe verymisleading. Again,seriousefforts at translatingandextending
thesetheoriesare required-including, in thiscase, attentionto themotivations
of publicbureaucrats and thehighlyconstraining conditions underwhichthey
seektoexercisecontrol.Publicbureaucrats do notwantthesamethingsas private
bureaucrats, and theytendto have farless flexibility and fewerresourcesfor
pursuing theirobjectives throughthecomplianceofsubordinates. Assuming these
pointsof comparisonare roughlycorrect,theymustsomehowbe reflected in
contractual theoriesifwe aretoarriveat a better understanding ofpublicbureauc-
racy.
HowCan PoliticiansControlBureaucrats?
Democraticpoliticsis easilyviewedin principal-agentterms.Citizensare
politiciansaretheiragents.Politicians
principals, areprincipals,
bureaucrats
are
theiragents.Bureaucraticsuperiorsareprincipals,bureaucratic
subordinates
are
theiragents.The wholeofpoliticsis thereforestructured
bya chainofprincipal-
fromcitizento politicianto bureaucratic
agentrelationships, superiorto bureau-

766 M. Moe
Terry
craticsubordinate and on downthehierarchy of government to thelowest-level
bureaucrats who actuallydeliverservicesdirectlyto citizens.Aside fromthe
ultimateprincipaland theultimate agent,each actorin thehierarchy occupiesa
dualrolein whichhe servesbothas principal andas agent.The formal apparatus
anddeductive powerof theprincipal-agent modelare applicableto each of these
hierarchicalstagesofgovernment, andmightusefully be employed in investigat-
ingeventhemostbasicquestionsofdemocratic controlandperformance.
Our concernat thispointis withthesecondstage,in whichpoliticiansare
principalsandbureaucrats theiragents.The modeloffers a simplereinterpretation
of the traditional problemof administrative accountability: whatinstitutional
mechanisms allowelectedofficialsto holdbureaucrats accountablefortheirad-
ministrative decisions?The reinterpretation, however, leads to a nontraditional
slanton thesubject.Theprincipal-agent modelfocuseson information asymmetry
and, in particular, on information availableto bureaucrats-abouttheirtrue
"types" (honesty, personalgoals,policypositions)andtheirtrueperformance-
thatpoliticiansdo notautomatically possessandoftencanonlyacquirewithmuch
imprecision and expense.It thenencouragesus to inquireintothemonitoring
devicesand incentive structures-aspects of institutionaldesign-thatmitigate
theasymmetry and thusminimizetheproblemsof adverseselectionand moral
hazardthatwillotherwise cause bureaucrats to departfromtheirpoliticaldirec-
tives.
Theexisting economicliterature on principal-agentrelationships is evennow
directlyhelpful,sincethepoliticians'controlproblemis buta special case of
moregeneralcontrolproblems thathavealreadybeenanalyzedin detail.In fact,
theproblemof politicalcontrolis analogousin manyrespectsto theeconomic
problemof theseparation of ownership and control,withpoliticiansattempting
tocontrol bureaucrats ratherthanstockholders trying tocontrolmanagers.Yet,as
we haveseen, thisworkcan takeus onlyso far.A good bitof translation and
elaboration are ultimately requiredif theyare to providereal insightintothe
substanceof politicalcontrol.Amongotherthings,principal-agent modelsmust
eventually finda wayofdealingwiththefollowing sortsofconsiderations.
1. As noted,theempiricaldiversity and ambiguity of individualgoals pre-
sentsa real modelingproblem,sincethereis no simplequantity likeincomeor
profitthatcan reasonably be thought tomotivate eitherbureaucrats orpoliticians.
Simplifying assumptions can and mustbe adopted,e.g., thatbureaucrats are
budget-or slack-maximizers or thatpoliticiansmaximizetheprobability of re-
election,butthereis likelyto be somedisputeas to whichareempirically appro-
priate-and, clearly,the ones we choose make quite a difference for our
theoretical"understanding"' ofpoliticalcontrol.A fewgeneralpointsaboutmo-
tivation,however, seemevident.First,becausepoliticians are notcentrally con-
cerned with economic efficiency, they will tend not to hold bureaucrats
accountableon efficiency grounds;in fact,politicianswill findmanykindsof
inefficiencyquitevaluable-e.g., thosethatinvolvepatronage orexpenditures in
thehomedistrict. Second,politicians arenotinterested in everything bureausdo.

Onlysomeaspectsbearon politicians'reelection chancesorpolicyinterests, and
thesearethefocusofpoliticalcontrol;theresttheywillignoreor perhapsuse as
bargaining chipswithbureaucrats andotherpoliticians. Thisis one foundation of
bureaucratic discretion.Third,politicians arenotnecessarily motivated toensure
thatbureaucrats faithfully pursuetheirstatutory mandates;themandateis a col-
lectiveexpressionof programmatic purpose,and individualpoliticiansmayor
maynotfinditspursuitrelevant to theirown self-interests. Whatthebureauis
"supposed" to be doingand whatpoliticians are askingitto do, therefore, may
oftenbe twoquitedifferent things.
2. Whatever politicians mightbe trying to accomplish in controlling bureau-
crats,theygenerally cannotcounton theeconomicresidualas thestockholders
of a corporation wouldin motivating theirmanagers.Theymight,however, be
able to counton slack. Particularly giventhatpoliticianscare littleabouteffi-
ciency,thismayin factbe a majortoolof politicalcontrol;forit is something
thatpoliticians can purposely provideandthatbureaucrats can subsequently con-
vertintoa rangeofothervaluedquantities. Yetitis also plaguedbyan information
asymmetry: bureaucrats are in a positionto knowwhatthelevelof slackis, but
politicians arenot(evenwithextensive andcostlymonitoring). Otherthings being
equal, thisputspoliticiansat something of a disadvantage, and mayencourage
relianceupon less demanding mechanisms, e.g., simplebudgetor stafflevels
(without estimates oftrueminimum costs),newprograms, selectivemonitoring,
ormediaattention.
3. Stockholders, likepoliticians, areburdened bysimilarinformation asym-
metriesin theirefforts to controlcorporate managers,buttheyare also blessed
bycertainexternal mechanisms thatsubstitute remarkably wellfordirectknowl-
edge-stock market evaluation of thecompany'sprofitability, labormarket eval-
uationofa manager'seconomicvalue,thethreat oftakeovers. Thesemechanisms
areclearlynotpresent forpublicbureaus,makingthemonitoring job ofpoliticians
farmoredifficult thanit wouldotherwisebe. Thereare, on the otherhand,
politicalmechanisms thatmayserveas partialsubstitutes. One is thereputation
of bureaucrats. Overtime,politiciansare able to observebureaucratic behavior
and,formanyof themoreimportant actors,arriveat tacitagreement as to their
honesty, competence, ideology,innovativeness, and otherqualitiesof relevance.
This is less concretethana market evaluation of economicworth,and it maybe
of littleuse in evaluating manypoliticalappointees,butit is certainly a central
tool in thetaskof politicalmonitoring. Anotherimportant tool is the "decibel
meter"(Weingast,1983; McCubbinsand Schwartz,1984), whichrefersto the
feedbackpoliticiansreceivefromconstituency groupsaffected by bureaucratic
performance. By complaining aboutservicedeliveryor demanding servicesof
different kinds,groupsprovidepoliticianswithcriticalinputsthatare directly
relevant bothto monitoring thebureacracy and furthering theirreelection goals.
As theseexamplessuggest,then,politicalmechanisms availabletopoliticians are
quitedifferent fromtheeconomicmechanisms availabletostockholders, andthey
are probably less effective in generating control-buttheyare characteristic fea-

768 M. Moe
Terry
turesof politicsthatfitcomfortably withina principal-agent framework, ifonly
we recognizetheirrelevance.
4. Politiciansoperateunderheavyconstraints in theireffortsto exercise
controloverbureaucrats. Mostaspectsofhiring,firing, andpromotion arestruc-
turedby formalcareersystemssuchas Civil Serviceand are manipulated only
withdifficulty. The president is in thebestpositionin theseregards,sincehe has
authority to hire(withsenatorial confirmation) and firea fewthousandpolitical
appointees; andpresidents haveoftenmadethesechoiceson thebasisofpolitical
philosophy or loyalty.But,evenhere,itis wellknownthatappointments arealso
frequently made on grounds(e.g., favorsto allies) thatare notconduciveto
subsequent control,and firingis oftenunlikely in viewof itsnegativereception
by the appointee'spoliticalsupporters. Similarly,
aspectsof organization that
politiciansmightwishto manipulate-formal goals, structure,decisionproce-
dures-are constrained bylegalstatutes, and,in theabsenceofcostlyandtime-
consumingnew legislativeefforts, beyondtheirreachin many
are effectively
respects.Whatis mostinteresting abouttheseconstraints, however,is notsimply
thattheyare so confining, but thattheyare imposedby thepoliticiansupon
themselves. Clearlypoliticianshavechosen-presumably in therationalpursuit
of theirown goals-to structure theformalcontextof theiragencyrelationship
withbureaucrats in sucha waythattheprospects forcontrolareactuallyreduced.
A simpleprincipal-agent modelcan onlyfindthiskindof behaviorparadoxical
indeed.
5. This promptsrecognition of a complicating butquiteessentialfactof
politics:anygivenbureauis likelytohavemultiple principals.Atthefederallevel
it will be subjectto directoversight by thepresident (throughtheOMB and the
departments) andseveralcongressional committees,witheachofthelatter bodies
comprisedof manypoliticians.Whetheror notwe considereverypoliticiana
principalin his own right,thecontextof controlis clearlya verycomplicated
one. Each principalis effectively in competition withtheothersin his efforts to
exertcontrol,whilethebureau,on thereceivingend of all this,findsit must
contendwithuncoordinated and oftenconflicting demands,requirements, and
incentives.Multiple-principal arrangements are not unusualin organizations,
sincesubordinate unitsoftentakeordersfrommorethanone superiorunit(ac-
counting, personnel); butan effort madebyorganizational
is ordinarily leadersto
imposeorderandconsistency. In democratic politics,however,partycompetition
tendsto promote multiple-principal arrangements thatarecompetitive rather than
cooperative, as none of theparties wants theothersto have control
unfettered over
thebureaucracy. And in a separationof powerssystem,competitive multiple-
principal arrangements areactuallybuiltintothesystem bydesign.The president
struggles withCongressovercontrolof thebureaucracy, and, withinCongress,
Housecommittees struggle withSenatecommittees. Thisis thewayadministra-
tiveaccountability is supposedto workin a separation of powerssystem:it is
literallytruethatno one is in charge.Bureausare "partialagents"of various
governmental principals, without beingunderthecompleteauthority of anyone

in particular,and without anycommonunderstanding of howauthority is legiti-

matelydividedamongthecompeting principals.Once we moveawayfromthe
simpleprincipal-agent modelby recognizingthatAmericanpoliticsis, by its
nature, a context ofcompetitive principals,itis hardly paradoxical thatpoliticians
imposeconstraints "on themselves."In fact,politiciansimposeconstraints on
oneanother ina competitive effort tosee toitthattheirowninterests areprotected
fromtheintrusions of politician-opponents. This is rationalforindividualpoliti-
cians and groupsof politicians,butthenetresultis thatpoliticiansin general
have a moredifficult timecontrolling thebureaucracy. This can onlytendto
strengthen thefoundations ofbureaucratic autonomy.
6. Politicalcontrolis also undermined bymultiple-agent arrangements. The
mostobviousof thesearisesbecauseeach principalhas variousbureausto over-
see; butthiscomplication maynotbe of greatsignificance, sinceprincipalsin
facthavetheirown specializedhierarchies formonitoring each bureauand, in
manycases, no coordination is evendesired.Anotherdimensionof multiple-
agentarrangements appearsfarmoreconsequential: politicalcontrolof a given
bureaurequiresnotonlythatpoliticians inducebureaucratic superiorsto comply
withtheirwishes,butthatbureaucratic superiors are subsequently able to induce
bureaucratic subordinates to complyas well. We havealreadyseenthatthissec-
ond step is highlyproblematic fora varietyof reasons.Thus, principal-agent
modelsthatfocuson relations betweenpoliticians andbureaucratic superiors will
be missinga necessarydimension of bureaucratic compliance,and modelsthat
focuson politicians and "bureaus" will tendto mergetwoquitedifferent kinds
of agencyrelationships without attentionto theirdistinctive contributions to bu-
reaucratic outcomes.
Whilehardlyexhaustive, thisdiscussionat leastbeginsto suggestthekinds
offactors thatbecomerelevant whenprincipal-agent modelsare appliedto ques-
tionsof politicalcontrol.Withthisas background, it is usefulto close thedis-
cussionby takinga brieflookat twointriguing perspectives nowcurrent in the
publicbureaucracy literature. Both proceed on rational choice foundations in
investigating therelationship betweenbureaucrats andlegislators. One,associated
withNiskanen(1971, 1975), arguesthatthisrelationship is dominated by bu-
reaucrats, whiletheother,associatedwithWeingast(Weingast,1983, Weingast
andMoran,1983),arguesjusttheopposite.Howdo theirarguments squarewith
thepoliticallogicofprincipal-agent analysis?
Niskanen'stheoryis a pioneering effortto explainthe rationalbases of
bureaucratic powerand budgetary outcomes.Verybriefly, he contendsthatbu-
reaucrats haveclose to a monopolyoverinformation aboutsupplycosts,which
theyuse alongwithinformation aboutlegislative"demand" to selectbudget-
outputpackagesthatare presented to legislatorsas take-it-or-leave-it
proposals.
Thiscombination of informational monopolyand agendacontrolallowsbureau-
cratsso to constrain legislators'optionsthatthey"have no choice" butto ratify
whatthebureaucrats want.Sincebureaucrats generally valuelargerbudgets(Nis-

770 TerryM. Moe
kanen,1971) andperhapsslack(Niskanen,1975), theoveralltendency is toward

budgetandoutputlevelsthatfarexceedthesocial optimum.
AlthoughNiskanen'stheorywas firstdevelopedbeforetheprincipal-agent
model,he focuseson information asymmetry and its implications forpolitical
control.Moreover, one of his partialsolutionsto thebig-government problemis
to rewardbureaucrats in proportion to theresidualtheyturnbackto thelegisla-
ture,againintroducing a controlmechanism centralto theprincipal-agent litera-
ture.Yetthereare fundamental differences betweenthetwo.Niskanenviewsthe
situationas one ofbilateral monopoly in whichthebureauhappenstoholdall the
cards,whereas,empirically, Congressis thebureau'ssuperior in thehierarchy of
governmental authority-itis theprincipal(or,in practice,its committees are)
and thebureauitsagent.As a principal, Congresstherefore has theauthority to
issue orders,adoptincentive systems, controlthebureaucratic agenda,and oth-
erwisestructure theprincipal-agent relationship as it sees fit(Millerand Moe,
1983a). Also, it can and generallyshoulddevise monitoring mechanismsfor
gathering information aboutbureaucratic "types" andproductive behavior(Bre-
tonandWintrobe, 1975). The principal-agent model,byviewingtherelationship
as hierarchical and emphasizing thedistinctivelydifferent positionsof superiors
and subordinates, naturally pointsto a whole arrayof resourcesand options
availableto thelegislature in itspivotalroleas principal.This does notmeanit
will succeedin dominating bureaucrats. We knowthelatterhave resourcesof
theirown,costinformation amongthem;and,as Niskanenhas noted,thelegis-
laturemay be subverted by high-demand committees thatact in league with
bureausbyseekinglargerbudgets.Butit does meanthatlegislatures maybe far
betteroffthanNiskanensuggests,due to theirspecial statusas governmental
superiors and all thatthatimpliesforthedynamics of control.It also meansthat
important elementsof a broaderunderstanding of politicalcontrol-thegoals of
politicians,theconstraints underwhichtheymustoperate,competition among
principals(includingthepresident), and otherfactorsdiscussedabove-tend to
be de-emphasized or ignoredas partof thegeneralinattention to issuesof hier-
archy.
Weingast,in contrastto Niskanen,explicitlyemploysa principal-agent
framework in asserting thatCongresssuccessfully engineers bureaucraticcompli-
ance. He notesthata conventional interpretation of theevidencepointsto the
oppositeconclusion,forCongressin factdoes a verypoorjob of directly moni-
toring bureaucratic behavior. Hearingsare sporadicandsuperficial, congressmen
are oftenill-informed or uninterested, and committees are overwhelmed by the
sheernumbers andcomplexity ofthebureaucratic decisionstheyarechargedwith
overseeing. It is notsurprising, then,thattheliterature tendsto portray Congress
as havinglittlesystematic influence overthebureaucracy. Weingastcontends,
however, thatCongresshas relieduponless visiblecontrolmechanisms thatsub-
stitutequiteeffectively formonitoring. (1) Membersof Congressassess bureau
performance by meansof theirconstituency "decibel meters,"themostdirect
measureof theimpactof bureaucratic performance on reelection.Theydo not

needto monitor performance closelyor in detail.(2) Bureausjudgedto be doing

a good job by thisstandardare rewarded(withbudgetsand programs);those
judgedto be doinga badjob are sanctioned. (3) Congresscontrols appointments
to bureaucratic positions,thusinfluencing the "types" of theindividualswith
whichtheydeal. (4) Bureaucrats knowthattheirsuccessin achieving bothcareer
goals and agencygoals dependson satisfying congressional interests. These
mechanisms operateunobtrusively toenableCongressto controlthebureaucracy.
Hearingsandotherpublicactsofcontrol areonlynecessary inthoserareinstances
whenbureausexceedtheirimplicitlimits-so it makessense thata Congress
exercising smooth,effective controloverbureauswill appearto be engagingin
onlysporadic,ineptoversight.
Weingast'sargument is a provocative challengeto conventional wisdomon
congressional influence.Itencourages a broader perspective inwhichbureaucratic
behavior is understood in institutional context, anditdirectsattention to themore
subtlewebofincentives andrelationships thatcondition politicalcontrol.Despite
theseusefulinsights, however, a gooddeal ofworkis calledforindeveloping the
model.Its premisesare highlydebatable-onecouldeasilyargue,forinstance,
thatCongressdoes notcontrolappointments andthatbureaucratic incentives are
notnearlyso conducivetocongressional influence.Itsconclusions, moreover, are
essentially assertedand thendocumented by reference to selectedempiricalex-
amples.Theyarenotformally or logicallyderived,andthereis no clearbasisfor
believingthatthecontrolmechanisms to whichhe pointsare as powerful as he
claims.Notingtherelevance ofthe"decibelmeter"is onething-demonstrating
thatitis indeedan efficient mechanism ofcongressional controlis quiteanother,
as is demonstrating theclaimthatdirectmonitoring is unnecessary. At present,
thereis nothing in theprincipal-agent literaturetojustifytheseconclusions about
Congress.And, as our discussionof the politicalcontextsuggests,thereare
plentyof considerations thatpointin otherdirections. Whataboutthepresident,
competition amongcommittees, and,in general,themultiple-principal setting in
whichall bureaucratic controltakesplace?Therearealso matters ofbureaucratic
motivation, constraintson legislators, difficulties
thatbureaucratic superiors have
in controlling subordinates-and, notleast,theinformation asymmetries thatthe
"decibelmeter"cannotmitigate.
Finally,thereis thequestionofwhatwe meanby "control."Ifcongressmen
do notcare aboutmanyand perhapsmostbureaucratic policydecisions,how
important is itthatCongresscontrolsbureaucrats on certainotherdecisions?By
thisinterpretation, congressional controlcan easilycoincidewithsubstantial bu-
reaucraticdiscretion, orperhapssystematic influence
presidential overthegeneral
directionsofbureaucratic policy.Moreover, arewe primarily interested in control
relationships withina set legal framework, or are we primarily interested in
whether changesin thelawsbringaboutchangesin bureaucratic behavior? Wein-
gast'sevidencetendsto bearon thelatterissue-but no one seriously doubtsthat
newlawshavean impacton whatbureaucrats do. The moreimportant theoretical
question,it seems,is theformer one of whether Congress(or presidents) can

772 TerryM. Moe
influencebureaucrats through oversight,appointments, budgets,etc., and thus

without passingnewlaws. Untiltheseandotherissuesof relevancecan be eval-
uatedsystematically,leadingto an explicitmodelof controlfromwhichconclu-
sionscanbe logicallyderived,thepositionthatCongresscontrols thebureaucracy
wouldappearto be moreprovocative thancompelling.
Atthispointin thedevelopment ofbureaucratic theory,however, provocative
positionsaredoubtless justwhatis neededto stimulate innovativeworkon public
organizations.Niskanenclaimsthatthebureaucracy dominates Congress,Wein-
gastclaimsthatCongresscontrols thebureaucracy, andbothappeartohavestaked
outuntenably extreme positions.Yettheirarguments clearlydo havesomething
new and important to tellus aboutthedeterminants of politicalcontroland the
foundationsofbureaucratic andcongressional power.Bureaucrats do havecrucial
informationaladvantages and certainabilitiesto engagein agendacontrol;Con-
gress'soutwardly poorperformance in monitoring thebureaucracy mayindeed
hidean effectiverelianceuponunobtrusive mechanisms. These are thesortsof
contributionsthattheoreticalprogressis builtupon.The taskforthefuture is to
incorporatetheseinsightsintomorecomprehensive models,perhapsprincipal-
agentmodels,thatprovidebroaderperspectives on politicalcontrol.
Conclusion
The basicpurposeofthispaperhas beento providepoliticalscientists with
an overviewof a newbodyof literature, theeconomicsof organization, and to
offera fewsuggestions abouthow it mightusefullybe appliedin thestudyof
publicbureaucracy.Myhopeis thatthisintroductory willhelptoimpose
treatment
simplicityand coherenceon a growing,complexbodyof research,and thatit
mayserveas a usefulstarting pointforthosewho wishto pursuetheseideas
further.
Twosimplethemesdeserveemphasisin conclusion.The firstis thatthenew
economicsoforganization is extraordinarily
promising. Fordecades,thestudyof
publicbureaucracy has beenone ofthemostunderdeveloped areasin all political
science.The workof Simon,March,andothersin thebehavioral traditionhas to
thispointbeenthemostpromising sourceof creativityandtheoreticalprogress;
butithasyettogenerate theamountsandkindsoftheoretical workitsproponents
hadhopedforandprobably wouldhavepredicted manyyearsback.The econom-
ics of organization
mayturnoutto be different. It shedsinteresting
newlighton
bureaucraticbehaviorbyfocusing on hierarchical
control-anelegant,beautifully
suitablefocusthatcapturestheessenceoforganizational andoffers
relationships
a coherent framework forintegrating boththebureaucratic and thepoliticaldi-
mensionsof administrative performance. Largelybecause it maintains theopti-
mizingmodelof choice,moreover, it offers
virtuallythefullrangeof powerful
analyticalmethodscharacteristic of neoclassicaleconomics,and it overlapsin
usefulandimportant wayswithbetter-developed areasofeconomics,information
in
economics particular. Forthesereasons,amongothers,manystudents ofpoli-

tics are likelyto findthecontractual paradigman especiallyattractive line of
inquiry.
Yetthisnewapproachalso has definite drawbacks that,in thisearlyperiod
ofnovelty andexcitement, threaten to go unnoticed. Whilehierarchical controlis
in somesensea narrowfocus,itstillprovesto be a verycomplexonethatsimple
modelsmayseverelydistort ratherthanclarify. The politicsof controltendsto
involvemultiple principals and agents,competition and cooperation, diversein-
dividualgoals, salientconstraints on choice, and a numberof otherfeatures
anchored in theinstitutional context. Foranalytical purposes,thereis a legitimate
inclination to assumeawayas manyof thesecomplications as possible-but it
maywellbe thatwe cannotexplainbehaviorto oursatisfaction, or evenroughly
predictit,without takingthesesortsofthingssystematically intoaccount.In the
shortrun,thissuggeststhatsimplemodelsthreaten to supplyus withtheoretical
"insights"thatare actuallyquiteincorrect; giventhedifficulty of conducting
empirical researchon suchtopics,these"insights"couldeasilygainacceptance
andserveto misleadus foryearsto come.In thelongrun,theinterplay oftheory
and data could well produce far more complex theoriesof dynamicpolitical
processesandrelationships, theories muchmorerepresentative ofpoliticalreality
thancurrent models-and muchmorecomplicated thanmodelerswouldlike. In
a worldof multipleactors,multipletimeperiods,and strategic behavior, thisis
surelya reasonableexpectation.
Thisbringsus backtothebehavioral paradigm.Themajorobjectiontowork
in thistradition has longbeen thatitsmodelsof dynamicprocessand adaptive
decisionmakingare too complicated to be useful.Yet,whilepartof theexcite-
mentsurrounding thecontractual paradigmis thatitavoidsall this,we haveseen
thatitmayultimately lead to modelseverybitas complexonceitrunsthegamut
ofempirical testingandmodification. Indeed,thesemodelsmaylookverymuch
likethoseemployedall alongin thebehavioral tradition.As theexcitement sur-
rounding thecontractual paradigmbeginsto catchon amongpoliticalscientists,
thissoberingpointof contrast is worthremembering. The contractual paradigm
is likelyto contribute moreto ourunderstanding of publicbureaucracy, particu-
larlyin thedangerousshortrun,if thebehavioralparadigmand its lessonsare
keptfirmly in mind.
submitted
Manuscript 4 November 1983
Final manuscript
received27 April1984
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The New Economics of Organization

Author(s): Terry M. Moe

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TerryM. Moe, Stanford

So far,positivepoliticaltheory has notcontributed muchto ourunderstand-

*For theirusefulcommentsand criticisms,

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Mycentralpurposehereis toprovidepoliticalscientists withan overview of

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externalities,and transaction costsinherent in actualcompetitive environments.

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omissionsof whichthesemodelsare accusedcan oftenbe handledwithinthe

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Thusemergesa rudimentary economicorganization, thefirm, centrally char-

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He also demonstrated in detailthatan organization theorycan indeedbe

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whenhe shirksby reducinghis effort expenditures, thesavingsin effort accrue

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themeasurement problem a negative factor,sincetheywanttheirtrueproductivity

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that,in mitigating the informationalasymmetries and structuring rewards,

The advantage ofa simpleanalytical framework is thatorganizational issues

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ing typicallyinvolvessubstantial elementsof hierarchy and monitoring. Most

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in particular,and without anycommonunderstanding of howauthority is legiti-

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kanen,1971) andperhapsslack(Niskanen,1975), theoveralltendency is toward

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needto monitor performance closelyor in detail.(2) Bureausjudgedto be doing

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influencebureaucrats through oversight,appointments, budgets,etc., and thus

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Alchian,ArmenA. 1950. Uncertainty,

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