Putting a Realistic Theory of Mind into Agency Theory: Implications for Reward Design and Management in Principal‐Agent Relations

Agency theory is one of the most important foundational theories in management research, but it rests on contestable cognitive assumptions. Specifically, the principal is assumed to hold a perfect (correct) theory regarding some of the content of the agent's mind, while he is entirely ignorant concerning other such content. More realistically, individuals have some limited access to the minds of others. We explore the implications for classical agency theory of realistic assumptions regarding the human potential for interpersonal sensemaking. We discuss implications for the design and management of rewards, and trace implications for value creation in principal‐agent relations.