Insights into Incentive Architecture in Marketing

“Show me the incentive and I will show you the outcome.”
— Charlie Munger, former vice chairman of Berkshire Hathaway

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Marketing is ultimately about creating value, which requires managing relationships across customers, channel partners, agencies, and platforms. Yet behind every successful interorganizational relationship lies something less visible but far more powerful: incentives.

My forthcoming chapter, "Agency Theory Perspectives on Interorganizational Relationships in Marketing", in the "Handbook of Interorganizational Relationships", builds on different research traditions in marketing to answer a fundamental question: 

How do firms create value when they must delegate decisions to other organizations whose interests may not perfectly align with their own?

This challenge is everywhere in modern marketing. Brands depend on digital advertising agencies to drive campaigns, they depend on resellers and channel partners to increase market reach and gain market shares, and they depend on platforms to amplify scale and visibility. 

In each case, decision-making authority is delegated from a principal (for example, a manufacturer) to an agent (such as a retailer or agency). When information is asymmetric and incentives are misaligned, partners may act opportunistically at the expense of the principal. Such problems known as moral hazard and adverse selection destroy value.

Agency theory provides a rigorous framework for understanding these dynamics. At its core, value in a relationship can be thought of as:

Value = First-Best Value – Agency Costs

The “First-Best” value corresponds to the value that could be achieved in an ideal world where incentives are perfectly aligned and information fully transparent. Agency costs represent frictions such as opportunism, gaming, hidden effort or misreporting that prevent that ideal outcome from materializing.

These frictions have tangible manifestations. For example, salespeople may shift effort toward short-term bonuses at the expense of long-term brand value. Advertising agencies may optimize metrics that serve their portfolio rather than a single client. Channel partners may deviate from pricing or branding guidelines when monitoring is weak. Not-for-profit leaders might allocate resources in the pursuit of personal career goals at the expense of efficiently fulfilling the mission of their organization.

The central managerial question then becomes: 

How should firms design contracts, monitoring systems, teams and incentives to minimize agency costs and maximize value creation?

Research has shown that formal incentives like performance-based contracts, and informal incentives like career concerns work, but can also create backfire. Nonlinear bonus plans can drive productivity, but they can also lead to strategic gaming. Monitoring systems may reduce opportunism, yet excessive oversight may undermine trust. Organizational design, team composition, and reputational concerns can function as powerful “incentives without contracts.”

For future leaders, the lesson is clear: strategy is not just about innovation and being different than competitors, it is also about fostering clever governance mechanisms. It is about anticipating how human, and increasingly, AI systems, respond when authority is delegated, information is imperfect, and objectives are not perfectly aligned.

In the case of the AI revolution, these considerations become even more important. Who will be accountable when agentic AI systems will fail? How should performance contracts evolve when value creation is shared between humans and AI tools?

For prospective MBA students at UC Davis, this research highlights a core leadership skill: incentive architecture, which relies on three principles.

• First, leaders must understand how agents respond to control mechanisms. Incentives do not simply motivate effort; they shape where, when, and how that effort is deployed.
   
• Second, agent characteristics matter. Differences in ability, risk tolerance, experience, and technological sophistication fundamentally influence how incentives are interpreted and acted upon.
   
• Third, context shapes control. Governance mechanisms that succeed in one setting may backfire in another. Culture, regulation, market structure, and technology all condition how incentives translate into behavior.

In summary, successful marketers know that strategy works when incentives do. Leaders who master incentive architecture don’t hope the stars align, they design them to.