Norms and financial incentives: A model of how to fund universities

Abstract

We derive the optimal compensation contract when two asymmetrically verifiable tasks are tied together, a cultural norm of behavior coexists with a financial incentive, and the amount of public funds is also a concern. To formulate our ideas, we restrict our attention to higher education. The model generates at least three results. First, the monetary incentive for research crowds out the social teaching norm. Second, increased intrinsic motivation in teaching induces a social multiplier effect. Third, the government underfunds the university if the university's teaching standard is lower than that of the government to implement its teaching standard.