Incentive Compatibility

Incentive compatibility means that the interests of two or more parties are aligned. In contrast, when interests are not aligned, the incentives governing behavior are considered incompatible. From an organizational perspective, incentive compatibility means that the incentives that motivate individual members in their actions are consistent with the organization’s goals. This entry defines incentive compatibility, discusses its relevance to adverse selection and moral hazard in the business context, and explains how it is framed as constraints in formal economic models.

Incentive compatibility is important in situations in which there is asymmetric information, that is, when at least one participant in the interaction knows more about the situation than another participant. A problem can occur when the participant with the more complete information uses that information in ...

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