The Hidden Costs of Not Using Discretionary Controls

Abstract

This study investigates the effect of a principal’s choice on the availability of discretionary controls, where discretionary controls are defined as those not supported by enforceable explicit contracts. In contrast to prior findings on explicit controls, we find that agent reciprocity is not significantly less when principals choose a discretionary control than when they are exogenously available. That is, we find no hidden costs of discretionary control. We tentatively attribute this finding to agents viewing discretionary controls as less intrusive than explicit controls. Interestingly, we find that agent reciprocity is less when principals choose to forgo discretionary controls than when the discretionary controls are not available. One explanation for this result is that agents perceive that principals who turn down the option to have discretionary controls available place less value on agents’ norm-adhering behavior than other principals. These findings support the often-used managerial practice of using discretionary controls.