Hidden Cost of Sanctions in a Dynamic Principal-Agent Model : Reactance to Controls and Restoration of Freedom

This study examines the effect of the principal’s control over the agent’s behavior in a dynamic principal-agent model with hidden information. We show the condition that the agent who has a similar preference for actions as the principal dares to choose the unpreferred action when the principal imposes a sanction on such an action. This also makes the principal worse off even when imposing sanctions is materially costless. When the principal incurs a cost on sanctions, they cease implementing them after observing the unpreferred action taken by the agent. Our results of the hidden cost of control correspond to the insight from the psychological reactance theory: when an agent’s freedom is threatened, they resist it to restore the freedom