Journal of the Operational Research Society

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Unobservable effort, objective consistency and

the efficiencies of the principal and the top
management team

Linlin Zhao, Yong Zha, Rui Hou & Liang Liang

To cite this article: Linlin Zhao, Yong Zha, Rui Hou & Liang Liang (2019) Unobservable
effort, objective consistency and the efficiencies of the principal and the top
management team, Journal of the Operational Research Society, 70:6, 1011-1026, DOI:
10.1080/01605682.2018.1487814

To link to this article: https://doi.org/10.1080/01605682.2018.1487814

Published online: 20 Feb 2019.

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JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY
2019, VOL. 70, NO. 6, 1011–1026
https://doi.org/10.1080/01605682.2018.1487814

ORIGINAL ARTICLE

Unobservable effort, objective consistency and the efficiencies

of the principal and the top management team
Linlin Zhaoa, Yong Zhab, Rui Houc and Liang Liangb
a
School of Business, Nanjing Audit University, Nanjing, Jiangsu Province, People’s Republic of China; bSchool of Management,
University of Science of Technology of China, Hefei, Anhui Province, People’s Republic of China; cSchool
of Management, Guangdong University of Technology, Guangzhou, Guangdong, People’s Republic of China

ABSTRACT ARTICLE HISTORY

Top management team (TMT) plays a leading role in making strategic decisions and busi- Received 2 September 2016
ness success. On account of unobservable and immeasurable characteristics of the TMT’s Revised 17 April 2018
Accepted 1 June 2018
effort, prior researches are of limited use in identifying its impact on the performances of
the principal and TMT. This paper formulates novel models to overcome the limitations by KEYWORDS
incorporating DEA and bi-level programming into the principal–agent framework. We begin Top management team;
with the basic models from the perspective of the principal and the TMT respectively, and efficiency; data
propose integrated and bi-level models to illustrate the cooperative and leader–follower col- envelopment analysis (DEA);
laboration between the two parties. We then develop an effort-based DEA model in which unobservable effort;
the effort of the TMT is viewed as a variable. By comparing optimal value of the variable objective consistence
with zero, we can identify whether the effort level is desired by the principal. A higher value
larger (lower) than zero implies that the members of TMT exert higher (lower) effort.
Further, we identify objective consistence between the two parties by incorporating the
organisational outcomes into the outputs of the TMT. A case study of 16 China listed real
estate companies shows that the TMT’s effort has a significant influence on the efficiencies
of the principal and the TMT. In addition, the TMT has an initiative incentive to adjust the
effort level to adapt various situations of objective consistence and inconsistence.

1. Introduction are assumed to have access to the same information

The top management team (TMT) plays a leading
role in making strategic decisions and business suc-
cess (Castanias & Helfat, 2001; Kor & Mahoney,
2000). They manage the resources of the firm effect-
ively and innovatively (Mahoney, 1995) and reflect
their knowledge and skills to professional manager-
ial experiences (Carpenter, Geletkanycz, & Sanders,
2004), which attract researchers to identify and
assess the competence of TMT (Hambrick &
Mason, 1984; Penrose, 1995).
In a stylish principal–agent framework, an owner
(the principal) has a primary stake in the performance
of an operational system, ie, a firm, and the TMT (the
agent) is delegated to have an operational control of
the system (a firm) with their professional knowledge
and skills. Members of the TMT (executives) exert
their efforts and reflect their knowledge, confidence
and imagination into the competence of the firm
(Herrmann & Datta, 2005; Kilduff, Angelmar, &
Mehra, 2000; Kor, 2003; Pitcher & Smith, 2001).
However, because the efforts cannot be explicitly
observable, hidden action (or moral hazard) often
occurs in practice (Mirrlees, 1999). The two parties
initially but the agent’s response cannot be observed
by the principal. In such case, the principal faces the
problem of providing incentives for the agent to take
the desired action and make the best of efforts.
Unfortunately, the classical economic models for the
principal–agent problem are of limited use to
researchers, because the principal cannot identify and
measure to what extent the members exert their
efforts explicitly. Correspondingly, the principal can
only make a vague and objective judgment implicitly
on the efforts from the organisational outcomes
(Finkelstein & Hambrick, 1990).
In particular, the relationship between the TMT
and the owner (the principal) can also play an
important role in the accomplishment of the firm’s
goal and affects the performances of both parties
differently. In some practices, the two parties work
in a cooperative manner and have the incentives to
take positive actions to benefit each other. In other
cases, the owner takes a dominant advantage over
the collaboration and the TMT is forced to make
effort and meet the objective of the firm involuntar-
ily. In such scenarios, the owner is viewed as a
leader and the TMT as a follower, see Van Ackere

CONTACT Yong Zha zhabeer@ustc.edu.cn School of Management, University of Science of Technology of China, Jinzhai Road 96, Hefei,
Anhui Province 230026, People’s Republic of China.
ß Operational Research Society 2019
1012 L. ZHAO ET AL.
(1993) for an overview of the topic. In addition,
objective consistence between the owner and the
TMT is another issue which attracts many
researches for further investigation. When the
objective of the TMT is inconsistent with that of the
principal, incentive incompatible problems might
take place (Maddigan & Zaima, 1985); when the
objective consistence between the two parties occurs,
ratcheting effect may happens. That is, TMT views
the organisational outcomes (ie, investment results)
as a reflection of their ability and capability, while
the principal views them as the return on capital.
However, human capital return is not fully consist-
ent with the capital return. When the firm earns a
higher level of the outcomes, the principal thinks it
to be the inevitable result of higher productivity of
the capital, which resulting in the increasing
requirement for the TMT in future contract.
Contrarily, when the TMT realises that the higher
level of outcomes derived from their efforts can
only lead to a higher expectation and harder oppres-
sive clause by the principal, the enthusiasm of the
members’ efforts will be reduced (Holmstrom & i
Costa, 1986). Conventional economic models cannot
explain how the principal designs different mecha-
nisms and encourages the TMT to take higher effort
to accomplish the objectives of both parties.
Despite the awareness of the significance of exec-
utives and their efforts in operating and managing
the firms effectively, little attention has been
devoted to investigating how the relationship
between the TMT and the owner and objective con-
sistence (or inconsistence) affect the TMT’s effort,
and consequently influence the performances of
both parties. In this study, we propose a general
framework for analysing the effort of the TMT.
Besides the theoretical interest, it can also shed light
on significant managerial problems. This paper
draws on multiple theoretical perspectives in build-
ing a model incorporating effort-based action of the
TMT to characterise the members’ effort and identi-
fies its effect on the performances of both parties. In
an effort to better describe the complex relationship
between the TMT’s effort level and the parties’ per-
formances, this paper attempts to model this issue
from performance perspective using data envelop-
ment analysis (DEA). Initiated by Charnes, Cooper,
and Rhodes (1978), DEA proves itself to be an
effective programming for measuring the relative
performance of peer decision making units with
multiple inputs and multiple outputs. The use of
DEA can bring a new flavour to the principal–agent
problem, because it is possible to measure organisa-
tional effectiveness and obtain ex post evaluation of
the relative efficiency of management accomplish-
ments (Boudreau, 2004).
We first propose two models to identify the per-
formances of the TMT and the principal from differ-
ent perspectives. In these models, the effort of the
TMT is ignored, whose purpose is to establish a base-
line for benchmark. Based on the base models, we dis-
cuss the possible relationships between the two parties
and distinguish their cooperation with an integrated
model and non-cooperation with bi-level program-
ming, respectively. We then extend the models to
characterise the effort of TMT as a decision variable.
The TMT can adjust his effort level to adapt various
scenarios with the desire to optimise his efficiency.
Similar to the role of return to scale in traditional
DEA context, the effort variable can also be an indica-
tor of the devoted effort level of the TMT.
Particularly, the variable larger than zero implies that
the TMT exerts a higher level of the effort. Contrarily,
the variable equal to or lower than zero implies that
TMT expends a moderate or lower level of the effort,
respectively. Further, we investigate the objective con-
sistence between the two parties which can also have
significant impacts on their efficiencies, by consider-
ing the organisational outcomes as one classification
of the TMT’s outputs.
It makes a theoretical contribution to the literature
by synthesising specific theoretical insights from DEA
theory (Charnes et al., 1978), performance-based view
and principal–agent based hidden action research.
Specifically, the models propose that the effort and
action of the TMT have crucial and distinct effects on
the TMT-specific, principal-specific and firm-specific
efficiencies. First, the base models involve the character-
istics of the efficiencies of two parties, which entail the
distinctive objectives between the two parties. Because
the owner pursues the investment return and the mem-
bers in TMT explore the return of their human resour-
ces and capabilities, their objectives are distinctive and
contradictive with each other. Second, their relationship
provides executives with different action and effort.
Because the TMT can work with the owner in different
manners, we distinguish such manners with cooperative
and non-cooperative and propose integrated model and
bi-level model to characterise such distinction. Third,
objective consistence involves whether the objective of
the owner is consistent with that of the TMT. It allows
us to identify effort change and efficiency change as
well in different scenarios.
We have three main methodological contributions
in this work. First, the analytical framework and
models are developed to measure the efficiencies of
the TMT and the principal. Second, we innovatively
characterise the effort level as a variable in DEA con-
text, which is similar to the estimation of return to
scale. Third, we portray potential and possible change
of the effort when the TMT encounters OC and
objective-inconsistent scenarios, which can help the

principal design incentive strategy under cooperative
and non-cooperative situations.
The remainder of the paper is organised as fol-
lows. Section 2 presents basic DEA models for the
principal–agent problem. Sections 3, 4 and 5 are
devoted to the development of efficiency measures
by extending the integrated and bi-level models. In
Section 6, the proposed models and efficiency meas-
ures are illustrated by an application to the effi-
ciency evaluation of 16 China listed real estate
companies. Conclusions are provided in Section 7.
2. Basic models of the
principal–agent problem
In modern organisations, instead of managing the
business by herself, the owner (“she” in this paper)
delegates the managerial authority to the salaried
TMT (“he” in this paper), and builds a contract for-
matting the principal–agent relationship (Zeckhauser
& Pratt, 1991). This involves two decision makers
who make independent decisions in an identical
organisation (Zhang & Zenios, 2008).
Figure 1 describes a typical structure, in which
each DMU (e.g., a firm) is composed of two decision
makers, the owner (principal) and the TMT (agent).
In the principal’s perspective, she invests various
resource xij ði ¼ 1; :::; IÞ to gain the outputs of the
firm, yrj ðr ¼ 1; :::; RÞ. She also pays the members of
the TMT with motivated payments, skj ðk ¼ 1; :::; KÞ,
which are viewed as one of the input classifications.
In the TMT’s perspective, he devotes human resour-
ces ldj ðd ¼ 1; :::; DÞ and takes actions (efforts) b0 to
earn the payments skj ðk ¼ 1; :::; KÞ from the owner.
In this way, the motivated payments are viewed as the
inputs of the owner and the outputs of the TMT from
various perspectives, which results in contradictive
interests between the two parties (Bogetoft, 1994).
It is worth noting that the inputs and outputs of
the principal can have impacts on the efficiency of the
TMT. For example, in real applications, an identical
TMT may receive different motivated payments in
different firms conditional on identical effort level.
Since xij is included in the estimation of the
principal’s efficiency, an inclusion of xij may have a
cross-impact on the two parties’ performances. In add-
ition, if xij is viewed as one of the inputs of the agent,
the agent may question that why he is responsible for
an input of the entire firm, when the organisational
(the principal’s) outputs may not capture the total
b0 skj
ldj skj xij yrj
j j
Figure 1. Principal-TMT structure.
JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1013
benefit from the agent (Holmstrom, 1979). In these
two perspectives, a trade-off on whether to choose xij
as the TMT’s input has to be considered. In this study,
our objective is to investigate the impact of unobserv-
able effort on the efficiencies of the parties, and explore
the interaction between the principal and the TMT and
its impact on the efficiencies. We prefer not to consider
xij as the TMT’s input, because it may distinguish the
inputs of one party with that of the other, which can
effectively eliminate the cross-effect of xij .
It is worth noting that the principal’s input xij
may not be controlled by the TMT completely. That
is, the input is suggested to be viewed as non-discre-
tionary (ND) or partially controlled. Various identi-
fications of the input xij can result in different
estimations of the TMT’s performance. We will
research the issue in future.
In this section, we will build a bridge between
the principal–agent problem and DEA, focusing our
attention on the performances of the parties.
2.1. The TMT’s efficiency
One of the basic prerequisites in DEA context when
evaluating the efficiency of TMT is to ensure that
the inputs and outputs can be specific and observ-
able. However in reality, b0 cannot be observed and
measured directly (Grossman & Hart, 1983;
Mirrlees, 1999). A simplified alternative is to ignore
the effort of the TMT, which is similar to the work
by Liu, Zhang, Meng, Li, and Xu (2011).
From the TMT’s perspective, given that the effort
is omitted, the members of the TMT exert their
human capital, such as knowledge, skills and experi-
ences to earn the payments from the principal. Their
inputs are characterised as the demography of the
TMT, such as average age, education and managerial
experience, and the outputs are the motivated pay-
ments, such as annual salary, reward, leisure (spare
time) and enjoyment cost. The traditional DEA
model, ie, CCR (Charnes et al., 1978), can be used to
estimate the efficiency of the evaluated TMT0 .
X
XK D
ea0 ¼ max wk sk0 vd1 ld0
k¼1 d¼1
X
K X
D (1)
s:t: wk skj vd1 lkj  1; j ¼ 1; :::; n
k¼1 d¼1
wk ; vd1  0; k ¼ 1; :::; K; d ¼ 1; :::; D
Annual
Effort Asset
Salary
Age Annual Equity
Education Salary Employees Net Profit
TMT Principal
Figure 2. The inputs and outputs.
1014 L. ZHAO ET AL.

Model (1) is a linear fractional program and can be 3. The efficiencies of the principal and TMT
transformed into the following linear program with
In previous section, we discuss the situation where the
traditional CCR transformation (Charnes–Cooper
principal and the TMT desire to optimise her/his effi-
transformation):
ciency independently. Since the payment is one of the
X
K output classifications of the TMT and one of the input
ea0 ¼ max Wk sk0 classifications of the principal, an inner linkage is
k¼1
formed between them, which affects their efficiencies
X
K X
D
s:t: Wk skj  Vd1 ldj  0; j ¼ 1; :::; n simultaneously. A question arises on how to characterise
k¼1 d¼1 (2) the linkage between two parties. In some practices, the
X
D executives devote themselves to manage the firms based
Vd1 ld0 ¼ 1 on the payments from the principal and have the incen-
d¼1 tive to make their effort level appropriate to the pay-
Wk ; Vd1  0; k ¼ 1; :::; K; d ¼ 1; :::; D ments. The more payments, the more effort they exert.
In this regard, we can make an identification that they
Suppose Wk and Vd1  are the optimal multipliers
work in a cooperative manner and desire to improve
of Model (2) and the efficiency of TMT0 is defined
P their efficiencies simultaneously. In other cases, the prin-
as ea0 ¼ Kk¼1 Wk sk0 . cipal possesses plentiful resources and has a dominant
advantage over the executives. The principal is viewed as
a leader and the TMT as a follower. In this way, the
2.2. The principal’s efficiency TMT has to take the objective of the principal as the
From the principal’s perspective, since she cannot first-order objective, while his own objective as the
observe the actions of the executives and make an second-order. We will depict the two situations with dif-
ferent models.
explicit identification of their effort, she can only
estimate the effort level from the outcomes of the
firm. Her performance is influenced by the inputs, 3.1. The integrated model
ie, investment, payments and the organisational
First, we characterise the linkage between the princi-
outcomes, ie, profit, strategic change, which can be
pal and the TMT in the cooperative context, in
depicted as:
! which the objective is to maximise the efficiencies of
XR  X K X
I
p 0
two parties simultaneously. We also assume that the
e0 ¼ max ur yr0 w k sk0 þ 2
vi xi0 weights of the payments in the TMT’s efficiency are
r¼1 k¼1 i¼1
 X ! equal to that in the principal’s efficiency, which is
X
R K X
I
similar to the work by Liang, Yang, Cook, and Zhu.
s:t: ur yrj w0 k skj þ vi2 xij  1; j ¼ 1; :::; n
r¼1 k¼1 i¼1 (2006) and Zha and Liang (2010). On the basis of
Model (2) and Model (4), we propose the following
ur ; vi2 ; w0 k  0; r ¼ 1; :::; R; i ¼ 1; :::; I; k ¼ 1; :::; K
model:
(3) 0 1
XK X R
Model (3) is a fractional programme and can be B wk sk0 ur yr0 C
B C
transformedR to the following linear programming:
1 B C
X ec0 ¼ max B k¼1 þ r¼1
C
p
e0 ¼ max Ur yr0 2 BX D X K X I C
@ 1
v ld0 wk sk0 þ v xi0 A
2
r¼1 d i
! d¼1 k¼1 i¼1
X
R X
K X
I
X
s:t: Ur yrj  W 0 k skj þ Vi2 xij  0; j ¼ 1; :::; n X
K D
r¼1 k¼1 i¼1 s:t: wk skj vd1 lkj  1; j ¼ 1; :::; n
k¼1 d¼1
X
K X
I
 X !
W 0 k sk0 þ Vi2 xi0 ¼ 1 X
R K X
I

k¼1 i¼1 ur yrj wk skj þ vi xij  1; j ¼ 1; :::; n

2

r¼1 i¼1
Ur ; Vi2 ; W 0 k ;  0; r ¼ 1; :::; R; i ¼ 1; :::; I; k ¼ 1; :::; K
k¼1
ur ; vi2 ; wk ; v1d  0; r ¼ 1; :::; R; i ¼ 1; :::; I;
(4)
k ¼ 1; :::; K; ; d ¼ 1; :::; D (5)
Model (4) assumes that moral hazard does not where the sum of two parties’ efficiencies is not the
occur and the effort of the agent is increasing in idea of total efficiency whereas a method to deal
the payment of the principal. Suppose Ur , Vi2  and with the cooperative situation in DEA context. In
W 0 k are the optimal multipliers of Model (4) this way, we can obtain the efficiencies of the two
and the efficiency of the principal is defined parties. In addition, we unify the weights of
P
as e0 ¼ Rr¼1 Ur yr0 . skj ðk ¼ 1; :::; KÞ, wk and w0 k into wk .
p

In DEA context, it is assumed that each party has
the incentive to maximise the efficiency in different
situations. Both parties have the same power to
influence the production system in a cooperative
setting. Accordingly, the objective is to maximise
the efficiencies of two parties simultaneously. In lit-
erature, the sum and product of the efficiencies are
two objectives which have been applied generally
(Liang et al., 2006; Liang, Cook, & Zhu, 2008; Kao
& Hwang, 2008; Zha & Liang, 2010).
There may exist the situation in which no final
outputs are produced. It implies that the efficiency
of the principal is equal to zero. However, the
TMT’s efficiency may not be zero because the final
outputs may not be the total benefit from the TMT
and the principal may offer the motivated payments
to the TMT. If the product formulation of the effi-
ciencies is adopted, the objective is zero and we can-
not obtain the TMT’s efficiency. Since DEA is an ex
post evaluation approach, the final output has no
impact on the existing relationship between the
principal and TMT. Specifically, it affects future
decision of the principal. For example, an occur-
rence of the situation may induce the principal to
examine the managerial activities of the TMT and
the business process. She may have the incentive to
improve the predicament by inducing a high effort
of the TMT or terminate the principal–agent con-
tract. Contrarily, the performance of the TMT can
be obtained from the sum formulation of the effi-
ciencies even if no final outputs are produced. In
this perspective, we make a trade off by choosing
the sum formulation
P in this study.
Let t1 ¼ 1= Dd¼1 vd1 ld0 , t1 vd1 ¼ Vd1 , t1 wk ¼ Wk ,
P P
t2 ¼ 1=ð Kk¼1 wk sk0 þ Ii¼1 vi2 xi0 Þ, t2 wk ¼Wk2 , t2 vi2 ¼Vi2 ,
t2 ur ¼Ur , d¼t2 =t1 , Wk2 ¼dWk , Model (5) can be con-
verted into the following linear program:
! Ackere, 1993).
1 X K XR
e0 ¼max
c
Wk sk0 þ Ur yr0
2 k¼1 r¼1
X
K X
D
s:t: Wk skj  Vd1 ldj 0; j¼1;:::;n
k¼1 d¼1
! level, usually the leader’s level, is dominant over the
X
R X
K X
I
Ur yrj  d Wk skj þ Vi xij 0; j¼1;:::;n ð6bÞ
2 lower level, generally the follower’s level. The leader
r¼1 k¼1 i¼1
X
D
Vd1 ld0 ¼1
d¼1
X
K X
I
d Wk sk0 þ Vi2 xi0 ¼1
k¼1 i¼1
Ur ;Vi2 ;Wk ;Vd1 0;r ¼1;:::;R;i¼1;:::;I;k¼1;:::;
K;d ¼1;:::;D ð6eÞ
JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1015
Note that skj ðk ¼ 1; :::; KÞ have dual roles: out-
puts for TMT and inputs for the principal, which
are described by constraint (6a) and (6b) respect-
ively. Solve Model (6) and we obtain the optimal
multipliers Ur , Wk , Vi2  and Vd1  . Consequently,
the efficiencies of the principal and TMT are e0 ¼
cp
PR 
PK 
r¼1 Ur yr0 and e0 ¼
ca
k¼1 Wk sk0 , respectively. If
cp
e0 ¼ 1 or eca 0 ¼ 1, it implies that the principal or
TMT is efficient; and the two parties are efficient if
both hold. P P
From the constraint d Kk¼1 Wk sk0 þ Ii¼1 Vi2 xi0
P
¼ 1, we obtain that d Kk¼1 Wk sk0  1. Since
P
eL0  Kk¼1 Wk sk0  eU0 , where eL0 and eU0 are the effi-
ciencies of the TMT in which the TMT is domi-
nated by the owner (principal) or dominates the
system, the extent of d can be specified as 0  d 
1
eL0
: See Appendix A for the solution of eL0 .
3.2. Bi-level programming
Besides the cooperative context where the effi-
ciencies of the principal and the TMT are opti-
mised simultaneously in previous sub-section,
non-cooperation can also exist between the par-
ties in practice. The leader (principal) sub-con-
tracts a job to the TMT (follower). The TMT is
rewarded by the principal according to the quan-
tity and quality of some random outcomes which
determine the leader’s revenue. At the lower
level, the TMT maximises an objective which is a
function of the reward and effort level. Such
non-cooperative situation can be mathematically
modelled by the use of bi-level programming
for modelling decentralised decisions (Van
The bi-level programming problem (BLP) is a
hierarchical optimisation problem consisting of two
levels where the constraints of one optimisation
ð6aÞ problem are determined by another optimisation
problem (Bard, 1983; Bard & Falk, 1982). The upper
makes the choice first to optimise his objective func-
tion. Observing the leader’s selection, the follower
ð6cÞ reacts accordingly which in turn affects the leader’s
outcome.
In this sub-section, we combine the BLP and
ð6dÞ DEA approach and propose an integrated BLP–DEA
model to evaluate the performance of the principal
and the TMT. Following the input–output forma-
tion of Models (2) and (4), we present the bi-level
(6) DEA model for DMU0 as
1016 L. ZHAO ET AL.

First level: 4.1. The TMT’s efficiency

bip
X
R In real applications, although the effort of the mem-
e0 ¼ max Ur yr0 bers in TMT cannot be observed by the principal,
r¼1
! the executives also have the incentive to maximise
X
R X
K X
I
their efficiency by adjusting the effort level.
s:t: Ur yrj  d Wk skj þ Vi2 xij
r¼1 i¼1
Specifically, when observing that the motivated pay-
k¼1
ment is higher than his expectation, the TMT pos-
 0; j ¼ 1; :::; n ð7aÞ sibly takes an active action and exerts a higher
X
K X
I effort to optimise his own efficiency. Contrarily,
d Wk sk0 þ Vi2 xi0 ¼ 1 ð7bÞ when perceiving that the motivated payment does
k¼1 i¼1 not meet his expectation, he possibly takes a nega-
tive action and exerts a lower effort to optimise his
Second level: own efficiency. In addition, when the motivated
X
K payment is near to his expectation, the TMT will
ebia
0 ¼ max Wk sk0 ð7cÞ maintain his current effort level. In this way, the
k¼1
executives can have the feasibility to adjust the level
X
K X
D
of their efforts in response to the
s:t: Wk skj  Vd1 ldj  0; j ¼ 1; :::; n ð7dÞ
k¼1 d¼1 principal’s motivation.
X
D In order to better describe how the TMT
Vd1 ld0 ¼ 1 ð7eÞ responds to the motivation of the principal, we
d¼1 define b0 as an indicator of the effort level of the
Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R; TMT. That is, based on the human capital
i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D ð7f Þ ldj ðd ¼ 1; :::; DÞ, the TMT can adjust b0 to corres-
(7) pond to the motivated payment skj ðk ¼ 1; :::; KÞ.
Given that s kj ðk ¼ 1; :::; KÞ is the expectation of the
In the first level of Model (7), the principal of TMT, if skj >s kj , b0 is suggested to be larger than 0,
the evaluated DMU determines on optimal multi- which implies that the executives have the intention
pliers Ur and Vi2 in order to maximise her effi- to take positive actions; if skj <s kj , b0 is suggested to
ciency. Based on the optimisation of Ur and Vi2 by be lower than 0, which means that they have the
the principal, TMT makes decisions on optimal incentive to take negative actions. skj ¼ s kj is a spe-
multipliers Wk and Vd1 in order to maximise his effi- cial case in which the executives think that the pay-
ciency. It is worth noting that the parameter d is ment is what they deserve and they will remain
similar to that in Model (6), which has a specified current level of effort. In this situation, b0 is equal
extent, ie, 0  d  e1L . The efficiencies of two parties to 0. Thus, b0 is a variable input and is assumed to
P
0
freely change as the TMT’ s will.
are defined as e0 ¼ Rr¼1 Ur yr0 and ebia
bip
0 ¼
PK  
In this study, we do not consider the effort as an
k¼1 Wk sk0 based on the optimal multipliers of Ur , environmental variable which influences the effi-
2  1
Vi , Wk and Vd . See Appendix B for the solution ciency of the agent. In classical principal–agent the-
of Model (7). ory, a generally accepted explanation of the effort is
a productive input with direct disutility for the
agent (Holmstrom, 1979). It implies that the effort
4. Modelling the effort of the TMT
has a non-trivial impact on the agent’s efficiency.
In Section 3, because the effort level b0 is unobserv- Consequently, the agent has the incentive to exert
able and cannot be measured explicitly, we simply appropriate effort motivated by the payment from
ignore the effort in efficiency evaluation of two par- the principal. However, one of the key characteris-
ties. However, plenty of researches have argued that tics of the environmental variable is the uncontroll-
the subjective effort is significantly related to the ability. If the effort is viewed as an environmental
performances of the principal and the TMT (Barki variable, it implies that the agent cannot control for
& Pinsonneault, 2005; Fong & Tosi, 2007; the effort possibly, which may not be consistent
Katzenbach, 1997). Such correlation is also verified with the principal–agent theory and practical situa-
by the practical industry. In this section, we will tions. In this perspective, we prefer an input variable
propose a novel method to identify the effort level to the effort instead of an environmental variable.
of the TMT, and investigate how the effort makes a Consequently, the agent can effectively adjust the
significant influence on the performances of effort level conditional on the human capital and
two parties. motivated payment.
 JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1017

Moreover, there may exist other unobservable the impacts of the effort on the utilities of the principal
factors which may affect the efficiency of TMT. In and the TMT, little research makes a measurement on
this study, we assume the effort level as the main the effort. In this study, we show b0 as a signal variable.
and significant unobservable variable. As one of the That is, the value of b0 is an indicator of whether the
most important issues which may result in the TMT exerts the level of the effort as the principal
dilemma of moral hazard, unobservable effort is a expects. In addition, the value of b0 may also illustrate
major concern in the principal–agent context. the relative level of the evaluated TMT’s effort with
Specifically, the research has been devoted to design that of the others. In this perspective, although b0 can-
incentive contracts to avoid moral hazard derived not give the accurate value of the effort, it may help the
from the unobservable effort (Hart & Holmstrom, principal identify whether moral hazard exists. In add-
1986). With such contracts, the agent has to exert ition, a more appropriate estimation of the effort may
efforts in accordance with the principal, which may be valuable for the principal–agent theory. We will
maximise the interests of both parties possibly. research the issue in future.
Since our pursuit is to investigate the impact of the
effort on the efficiencies of the parties, we do not 4.2. The integrated model
consider the other unobservable factors. How other
unobservable factors may affect the performances of Similar to Model (6), we propose the following
the parties will be explored in our future research. model to illustrate the influence of the TMT’s effort
The efficiency of the TMT can be estimated as on the efficiency.
traditional DEA model similar to the work by
!
Banker, Charnes, and Cooper (1984).
! 1 X K XR
ec0¼ max Wk sk0 þ Ur yr0
X K XD
2 k¼1
e0 ¼ max wk sk0 =
a
vd ld0 þ b0
1 r¼1
!
k¼1 d¼1 X
K X
D
! s:t: Wk skj  Vd ldj þ b0  0; j ¼ 1; :::; n
1 A
X
K X
D
s:t: wk skj = vd1 lkj þ b0  1; j ¼ 1; :::; n (8) k¼1 d¼1
!
k¼1 d¼1 X
R X
K X
I
Ur yrj  d Wk skj þ Vi2 xij  0; j ¼ 1; :::; n
wk ; vd1  0; k ¼ 1; :::; K; d ¼ 1; :::; D r¼1 i¼1
k¼1
b0 is free X
D
Vd1 ld0 þ bA0 ¼ 1
Model (8) can be converted into the following d¼1
linear program. X
K X
I

X
K d Wk sk0 þ Vi2 xi0 ¼ 1
ea0 ¼ max Wk sk0 k¼1 i¼1
k¼1
! Ur ; Vi ; Wk ; Vd 
2 1
0; r ¼ 1; :::; R;
X
K X
D
i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D
s:t: Wk skj  Vd1 lkj þ bA0  0; j ¼ 1; :::; n
k¼1 d¼1 bA0 is free (10)
X
D where the objective is to maximise the arithmetic
Vd1 ld0 þ bA0 ¼ 1 average efficiency of the principal and the TMT. d
d¼1 is a parameter and its range can be estimated simi-
Wk ; Vd1  0; k ¼ 1; :::; K; d ¼ 1; :::; D lar to that in Model (6). Correspondingly, the effi-
P
cp
bA0 is free ciencies of two parties are obtained as e0 ¼ Rr¼1
(9) P
Ur yr0 and eca
0 ¼
K 
k¼1 Wk sk0 with the optimal solu-
where bA0 indicates the effort level of the TMT. tions of Ur , Vi2  , Wk , Vd1  and bA0  from
Given that Wk , Vd1  and bA0  are the optimal multi- Model (10).
pliers from Model (9), the efficiency of the TMT is Model (10) differs from Model (6) in that it
P
obtained as ea0 ¼ Kk¼1 Wk sk0 . Different from Model quantifies the effort of the TMT in a cooperative
(2), Model (9) characterises the role of the TMT’s scenario and discusses its influence on the efficien-
effort on the performance and well depicts the influ- cies of the principal and the top management.
ence on the efficiency change.
Then we can say that (1-a) bA0  <0 () Effort not-
4.3. Bi-level programming
enough or lower effort (1-b) bA0  ¼ 0 () Effort appro-
priate or indifferent effort (1-c)bA0  >0 () Effort Similar to Model (7), we propose a bi-level pro-
enough or higher effort. gramming in DEA context to well investigate the
It is worth noting that, although prior researches in effort’s influence on the performances of two parties
principal–agent context have been devoted to consider when the principal is followed by the TMT.
1018 L. ZHAO ET AL.

First level: environment. In addition, the inefficiency of the agent

X
R may result from the shortage of human resources and
bip
e0 ¼ max Ur yr0 other environmental factors.
r¼1
!
X
R X
K X
I
s:t: Ur yrj  d Wk skj þ Vi2 xij 5. Objective consistency between the
r¼1 k¼1 i¼1 principal and the TMT
 0; j ¼ 1; :::; n Prior researches (Dasgupta, Hammond, & Maskin,
X
K X
I 1979; Laffont & Martimort, 2009; Vohra, 1999) discuss
d Wk sk0 þ Vi2 xi0 ¼ 1 the situation where the objective of the TMT is incon-
k¼1 i¼1
sistent with that of the principal, which may lead to
Second level: incentive incompatibility problems. In such situation, if
X
K the efficiency of the TMT is lower, they may not accept
ebia
0 ¼ max Wk sk0 the employment of the principal. In addition, the TMT
k¼1
! has informational advantage about the effort which is
X
K X
D
unobservable by the principal, and may have the incen-
s:t: Wk skj  Vd1 ldj þ bA0 tive to maximise his own interest by sacrificing the
k¼1 d¼1
profit of the principal. This may exacerbate the object-
 0; j ¼ 1; :::; n
(11) ive inconsistency between the two parties. Especially,
X
D
when the principal uses her stronger market power to
Vd1 ld0 þ bA0 ¼1
d¼1
seize more resources by sacrificing the TMT’s benefit,
she is acting as a leader and the follower will not par-
Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R;
ticipate in the contract or will hide his actions (Wu,
i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D Luo, Wang, & Birge, 2014). A possible solution for the
bA0 is free principal is to allow the TMT to participate in the allo-
cation of the organisational outcomes (eg, Wu et al.,
In the first level of Model (11), the principal of
2014). The members in the TMT will consider outcome
the evaluated DMU determines on optimal multi-
maximisation of the principal as one of their own goals,
pliers Ur and Vi2 in order to maximise her effi-
instead of the payment solely. In this regard, we present
ciency. Based on the optimisation of Ur and Vi2 by
an OC strategy to motivate the follower to participate
the principal, TMT makes decisions on optimal
in the activity.
solutions of Wk , Vd1 and bA0 in order to maximise
his efficiency. d is a parameter and its range
can be estimated similar to that in Model (7). 5.1. The OC efficiency of the TMT
Correspondingly, the efficiencies of two parties are
P Based on Model (9), the TMT concerns about the
obtained as e0 ¼ Rr¼1 Ur yr0 and ebia
bip
¼
PK  
0
2 organisational outcomes of the principal, and his
k¼1 Wk sk0 with the optimal solutions of Ur , Vi ,
efficiency is estimated by
Wk , Vd1  and bA0  from Model (11).
Similarly, different from Model (7), Model (11) X
K X
R

quantifies the effort of the TMT in a non-coopera- ea0 ¼ max Wk sk0 þ Ur yr0
k¼1 r¼1
tive scenario and discusses its influence on the effi- !
X
K X
R X
D
ciencies of the principal and the top management. s:t: Wk skj þ Ur yrj  Vd1 ldj þ bA0
It is worth noting that, the value of bA0  is also an indi- k¼1 r¼1 d¼1
cator of whether moral hazard occurs in both coopera-  0; j ¼ 1; :::; n
tive and non-cooperative situations. A value of bA0 
X
D
lower than 0 implies that the TMT’s effort does not Vd1 ld0 þ bA0 ¼ 1
achieve the expectation of the principal and moral haz- d¼1
ard exists. The inefficiency of the principal may be Ur ; Wk ; Vd1  0; r ¼ 1; :::; R; k ¼ 1; :::; K; d ¼ 1; :::; D
derived from the ineffective effort of the TMT, and the
bA0 is free
inefficiency of the agent may be derived from the inad-
equate motivated payments. On the contrary, a value of (12)
bA0  not lower than 0 indicates that the TMT’s effort where the objective of the TMT is to maximise his
achieves the principal’s expectation and no moral hazard payments and the organisational outputs as well.
occurs. Consequently, the inefficiency of the principal Correspondingly, the efficiency of the TMT is
P P
may result from the ineffective inputs and other external defined as ea0 ¼ Kk¼1 Wk sk0 þ Rr¼1 Ur yr0 . The dif-
factors such as economic environment and political ference between Models (12) and (9) lies in that the
 JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1019

former depicts the situation where the TMT links his Second level:
benefit with that of the principal, while the latter focuses X
K X
R
on the inconsistence of the two parties’ objectives. ebia
0 ¼ max Wk sk0 þ Ur yr0
k¼1 r¼1
!
X
K X
R X
D
5.2. OC integrated model s:t: Wk skj þ Ur yrj  Vd1 ldj þ bA0
k¼1 r¼1 d¼1
Based on Models (4), (10) and (12), we construct
the integrated model by using the objectives of the  0; j ¼ 1; :::; n
(14)
two parties. X
D
Vd1 ld0 þ bA0 ¼1
1X K
1 XR
max Wk sk0 þ ð1 þ dÞ Ur yr0 d¼1
2 k¼1 2 r¼1 Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R;
!
X
K X
R X
D i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D
s:t: Wk skj þ Ur yrj  Vd1 ldj þ bA0
k¼1 r¼1 d¼1
bA0 is free
 0; j ¼ 1; :::; n where the range of the parameter d is same as in
!
X
R X
K X
I Model (13). Solving Model (14), we can get the effi-
P
d Ur yrj  d Wk skj þ Vi2 xij ciencies of the two parties, e0 ¼ d Rr¼1 Ur yr0 and
bip
P P
r¼1 k¼1 i¼1
e0bia ¼ Kk¼1 Wk sk0 þ Rr¼1 Ur yr0 , respectively.
 0; j ¼ 1; :::; n (13) Similarly, Model (14) differs from Model (11) in
X
D that the former depicts the situation where the TMT
Vd1 ld0 þ bA0 ¼ 1 links his benefit with that of the principal, while the
d¼1
latter focuses on the inconsistence of the two parti-
X
K X
I
d Wk sk0 þ Vi2 xi0 ¼ 1 es’ objectives.
k¼1 i¼1 It is worth noting that the effort and efficiency of
Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R; the TMT may change conditional on an identical
objective between the two parties in both coopera-
i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D
tive and non-cooperative settings. Consequently, the
bA0 is free efficiency of the principal may change as well. A
By selecting an appropriate parameter d(similar detailed explanation of the variances can be illus-
to Model (6)), the efficiencies of the two parties trated by the numerical analysis in Section 6.
P PKare
obtained Pas e0 ¼ d Rr¼1 Ur yr0 and eca
cp
0 ¼ k¼1
Wk sk0 þ Rr¼1 Ur yr0 with the optimal solutions of 6. Numerical analysis
Ur , Vi2  , Wk , Vd1  and bA0  from Model (13).
Similarly, Model (13) differs from Model (10) in In this section, we illustrate the feasibility and
that the former depicts the situation where the TMT appropriateness of our approach. Due to the avail-
links his benefit with that of the principal, while the ability of the data, we collect the data of 16 real
latter focuses on the inconsistence of the two parti- estate companies in China from the 2012 China
es’ objectives. Stock Market Financial Statements Database and
China Listed Firm’s Corporate Governance Research
Database provided by the CSMAR.
5.3. OC bi-level DEA model
When the principal is a leader and the TMT is a 6.1. Case description
follower, their efficiencies can be estimated by
First level: In this case, we select the asset (millions yuan),
equity (millions yuan) and numbers of employees as
bip
X
R
e0 ¼ max d Ur yr0 the inputs and net profit (millions yuan) as the out-
r¼1 puts of the principal, which is similar to the work
!
X
R X
K X
I by Seiford and Zhu (1999).
s:t:d Ur yrj  d Wk skj þ Vi2 xij As to the TMT, there is a large empirical man-
r¼1 k¼1 i¼1
agement literature that investigates the role of
 0; j ¼ 1; :::; n human capital on organisational outcomes (eg,
X
K X
I Barkema & Pennings, 1998; Beckman, Burton, &
d Wk sk0 þ Vi2 xi0 ¼ 1 O’Reilly, 2007; Bertrand & Schoar, 2003). Williams
k¼1 i¼1
and O’Reilly (1998) report that over 40 empirical
1020 L. ZHAO ET AL.

Table 1 Data set.

x1 x2 x3 l1 l2 s y
DMUs Asset Equity Employee Age Edua ASM Net profit
SZZY 9,343 3,549 290 47.88 0.47 7.0302 629.57
BAHRE 2,868 1,165 934 49.69 2.85 6.1903 194.1
OW 30,935 8,962 3058 50 5.5 12.2169 778.05
RONG AN 10,729 2,802 524 48.63 4.22 4.23 424.27
ZHONG TIAN 5,878 1,138 248 48.17 3.5 1.9498 49.83
JINGKE 13,043 5,601 1,713 48.38 5.52 8.6793 163.59
TAI HE 13,640 2,374 1,382 51 4.33 4.026 315.55
GUANG YU 7,107 2,308 3,932 43.97 6.32 3.365 271.14
SHCH 21,955 8,913 6,513 53.74 6.21 7.515 746.75
CHANG JING 4,455 2,407 351 46.64 0.4 3.7216 9.96
TIAN FANG 12,198 4,989 421 54.86 5.73 3.8593 337.19
TIAN HONG 70,864 13,949 2,018 48.78 1.41 11.6241 1,536.09
WAN YE 7,153 2,666 224 49.05 0.48 3.2627 110.05
DMC 10,385 3,532 743 53.06 3.11 5.6539 253.66
SHI MAO 37,084 13,952 2,255 43.89 5.11 9.6582 1401.03
BEI CHEN 29,484 10,196 4,951 53.25 6.04 8.0502 609.56
a
Edu indicates the average educational year.

Table 2. Descriptive statistics.

the principal. An alternative is to also view man-
Variables Min Max Mean Std. dev
agerial stockholding level (%) as one of the moti-
x1 Asset (millions yuan) 2868 70864 17945.06 17382.631
x2 Equity (millions yuan) 1,138 13,952 5,531.44 4,313.550 vated payments. From the principal’s perspective,
x3 Numbers of employees 224 6,513 1,847.31 1,885.725 the annual salary is a short-term incentive and the
l1 Average age 43.89 54.86 49.4369 3.1966
l2 Average educational year 0.40 6.32 3.8250 2.1566 managerial stockholding is a long-term incentive.
s Annual salary of 1.9498 12.2169 6.3145 3.1050 However, due to the availability of the data, we only
management
(millions yuan) choose the annual salary as the motivated payment.
y Net profit 9.96 1536.09 489.3994 449.5518 Fortunately, the proposed model can be easily
(millions yuan)
extended to include various motivated payments.
The inputs and outputs of the principal and the
studies have examined the effects of TMT demog- TMT can be reported in Figure 2.
raphy on firm outcomes, team dynamics and the The original data and its descriptive statistics are
firm. It is relatively uncontroversial to claim that provided in Tables 1 and 2.
human capital, ie education and experience, is asso-
ciated with the firm performance (Beckman et al.,
2007). Entrepreneurship scholars have demonstrated 6.2. Computational results
that the quality of the team’s past experience bene- Table 3 reports the efficiencies of the principal and
fits the firm (ie, Burton, Sørensen, & Beckman, the TMT in different scenarios. It is obvious that
2002; Chandler & Hanks, 1998; Schefczyk & the efficiencies of two parties when optimised inde-
Gerpott, 2001). In this study, we propose the human pendently (Models (2) and (4)) are larger than that
capital stock as the human resources of the TMT. In in cooperative or leader–follower scenarios. In add-
particular, the average age of the executives repre- ition, the efficiency of the principal in bi-level pro-
sents social practice capability, and average educa- gramming is larger than that in integrated model,
tional year indicates the mind, learning ability, etc. and the opposite situation occurs on the efficiency
In literature relative to TMT, the age and educa- of the TMT. Since the reason is obvious, we do not
tion of the TMT may have impact on the effort level. discuss it in detail.
Holmstrom (1999) proposes the reputation model Table 4 reports the efficiencies of the principal
and illustrates that the effort level decreases with the and the TMT in various scenarios.
age, because the reputation effects decrease with the
increases of the age. This can well explain why 1. bA0 well illustrates the effort level of the TMT. If
younger managers exert more efforts. Hambrick and bA0 >0, the executives exert a higher level of the
Mason (1984) and Carpenter et al. (2004) develop effort. Contrarily, if bA0 <0, the executives take
upper echelons theory (UET) and also investigate the managerial actions with lower effort.
impact of TMT’s education level on group decision Particularly, the TMT of SHI MAO shows a
making and effort of the team. Although it is valuable relatively lower level of the effort, ie, –758.15
to discuss the influence of the age and education on and –2,337.88.
the effort, it may be beyond our focus in this study, 2. Model (9) records the efficiencies of the TMT
and we will further investigate the relationship among from his own perspective. The data shows that
them by incorporating UET. the efficiency of a TMT is higher if bA0 is
In addition, the annual salary of management smaller and the efficiency of a TMT is lower if
(ASM, ¥millions) is the motivated payment from bA0 is higher. It implies that the executives can
 JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1021

get higher returns from the principal given that
they exert a lower effort level. Such situation
accords with the industrial practices that the
TMT may not work hard as the principal
expects. However, because she cannot observe
the real action and effort he takes, the incentive
payment is in favour of the TMT. A contradict-
ory fact is that the executives can only get lower
returns even if they exert a higher effort level.
3. Model (10) records the efficiencies of two par-
ties in the cooperative context. Comparing with
8 TMTs with lower efforts (bA0 <0) in Model (9),
the number increases to 10 in Model (10). It
depicts that the efforts of some TMTs decrease
even if they work with the principals coopera-
tively. Take the firm WAN YE for an example,
the efficiency of the TMT is 0:4609 given that
the effort is 0:6686. Contrarily, the efficiency
decreases in a larger extent to 0:3986 which
induces the executives with a lower effort, ie
–2.3652. A similar situation occurs in BAHRE
firm. The possible reason may be that, under
cooperative situation, (1) the TMT thinks that
the principal can benefit more from the higher
effort than himself; (2) the TMT perceives
unfairness from the principal. Consequently, the
executives decrease their effort levels, which
results in a lose–lose consequence.
Table 5 reports the efficiencies of the principal
and the TMT considering the effort of the TMT
and objective consistence between two parties.
1. In Model (12), when the TMT takes the output
of the principal as one of his output classifica-
tions, he has the incentive to adjust the effort
level. However, the corresponding change of
the efficiencies is not obvious. This can be
seen from the average effort in the tables. For
example, the average means of the efficiencies
from Models (9) and (12) are 0:6262 and
0:6279, respectively. It implies that the TMT
does not overvalue the outputs of the princi-
pal when he optimises his own
efficiency.
2. In Model (13), when cooperating with the prin-
cipal, the TMT will adjust his effort level to
some extent in order to optimise their efficien-
cies. In Model (12), 8 TMTs show lower levels
of the effort (bA0 <0). Contrarily, in Model (13),
the number of the TMTs decreases to 6. For
example, the TMT of RONG AN changes his
Table 3. Efficiencies with no consideration of the effort bA0
and objective consistence.
Model (6) Model (7)
Model (2) Model (4)
DMUs ea0 ep0 eca
0 ecp
0 ebia
0 ebip
0

4. In Model (11), the bi-level programming identi- SZZY 1.0000 1.0000 0.8543 1.0000 0.0430 1.0000
BAHRE 0.5182 1.0000 0.0035 1.0000 0.0027 1.0000
fies that the principal is a leader and the TMT OW 1.0000 0.6115 1.0000 0.4390 0.5739 0.6115
is a follower. One party has to take the other RONG AN 0.3585 1.0000 0.2210 1.0000 0.2161 1.0000
ZHONG TIAN 0.1676 0.2692 0.1070 0.2672 0.0973 0.2692
into consideration when optimising his effi- JINGKE 0.7342 0.2018 0.7342 0.1299 0.4730 0.2018
ciency. This encourages the TMT to choose a TAI HE 0.3256 0.8221 0.2071 0.8165 0.1882 0.8221
higher level of the effort instead of a GUANG YU 0.3132 0.7994 0.1857 0.7994 0.1857 0.7994
SHCH 0.5723 0.7965 0.5723 0.6850 0.2760 0.7965
lower level. CHANG JING 0.6220 0.0332 0.6220 0.0185 0.0016 0.0332
5. Comparing with Table 3, the efficiencies of the TIAN FANG 0.2884 0.7907 0.1997 0.7907 0.1997 0.7907
TIAN HONG 1.0000 1.0000 1.0000 0.9110 0.6353 1.0000
principal with bi-level programming in Table 4 WAN YE 0.4544 0.3435 0.3930 0.3080 0.3540 0.3435
remain constant, while that of the TMT increase DMC 0.4430 0.4626 0.4430 0.3093 0.2731 0.4626
SHI MAO 0.9006 1.0000 0.9006 1.0000 0.4241 1.0000
with an unobvious extent instead. BEI CHEN 0.6187 0.5612 0.6187 0.5220 0.2835 0.5612
Mean 0.5823 0.6682 0.5039 0.6248 0.2642 0.6682

Table 4. Efficiencies considering the effort bA0 .

Model (9) Model (10) Model (11)
DMUs ea0 bA0 eca
0 ecp
0 bA0 ebia
0 ebip
0 bA0
SZZY 1.0000 –2.597 0.8543 1.0000 –3.1238 0.2331 1.0000 0.3614
BAHRE 0.5231 0.9651 0.0035 1.0000 –2.1175 0.0028 1.0000 0.2102
OW 1.0000 0.6020 1.0000 0.4390 0.5046 0.5739 0.6115 0.2209
RONG AN 0.3641 –0.7547 0.2244 1.0000 –3.3453 0.2169 1.0000 0.4998
ZHONG TIAN 0.1709 –0.7684 0.1091 0.2672 –4.7168 0.0992 0.2692 0.3480
JINGKE 0.7522 –0.7559 0.7522 0.1299 –0.7559 0.4846 0.2018 0.4531
TAI HE 0.3342 0.9479 0.2126 0.8165 0.0034 0.1932 0.8221 0.5652
GUANG YU 0.3472 –0.8999 0.2115 0.7942 –192.06 0.2059 0.7994 0.2789
SHCH 0.6151 1.0000 0.6151 0.6850 1.0000 0.2967 0.7965 0.5587
CHANG JING 1.0000 –380.60 1.0000 0.0185 –807.85 0.0026 0.0332 0.1051
TIAN FANG 0.3159 1.0000 0.2187 0.7907 0.5769 0.2187 0.7907 0.6580
TIAN HONG 1.0000 –2.716 1.0000 0.9110 –1.2980 0.5788 1.0000 0.1004
WAN YE 0.4609 0.6686 0.3986 0.3080 –2.3652 0.3591 0.3435 0.1949
DMC 0.4763 0.9620 0.4763 0.3093 0.9620 0.2936 0.4626 0.3658
SHI MAO 1.0000 –758.15 1.0000 1.0000 –2337.88 0.4994 1.0000 0.2234
BEI CHEN 0.6589 1.0000 0.6589 0.5220 1.0000 0.3019 0.5612 0.5452
Mean 0.6262 –71.26 0.5459 0.6245 –209.47 0.2850 0.6682 0.3556
1022 L. ZHAO ET AL.

Table 5. Efficiencies considering the effort bA0 and objective consistence.

Model (12) Model (13) Model (14)
DMUs ea0 bA0 eca
0 ecp
0 bA0 ebia
0 ebip
0 bA0
SZZY 1.0000 –6.3684 1.0000 1.0000 –7.0058 1.0000 1.0000 0.1341
BAHRE 0.5231 0.9651 0.1264 0.9950 1.0000 0.1264 0.9950 1.0000
OW 1.0000 0.1268 0.6358 0.5713 1.0000 0.6358 0.5713 1.0000
RONG AN 0.3643 –0.6770 0.2808 0.8676 0.0876 0.2808 0.8676 0.0876
ZHONG TIAN 0.1709 –0.7684 0.0664 0.2672 –1.9557 0.0623 0.2692 0.3537
JINGKE 0.7522 –0.7559 0.3499 0.1299 –1.5808 0.2620 0.2018 0.4548
TAI HE 0.3342 0.9479 0.2170 0.7638 1.0000 0.2170 0.7638 1.0000
GUANG YU 0.3472 –0.8999 0.2130 0.7068 0.0113 0.2130 0.7068 0.0113
SHCH 0.6315 1.0000 0.5255 0.6838 1.0000 0.5255 0.6838 1.0000
CHANG JING 1.0000 –492.40 1.0000 0.0192 –835.77 0.0186 0.0186 0.0000
TIAN FANG 0.3215 1.0000 0.2506 0.6092 1.0000 0.2506 0.6092 1.0000
TIAN HONG 1.0000 –0.2810 1.0000 0.7956 –1.8782 1.0000 0.7956 0.2429
WAN YE 0.4609 0.6686 0.2950 0.3248 0.4429 0.2950 0.3248 0.4429
DMC 0.4763 0.9620 0.2527 0.4529 1.0000 0.2527 0.4529 1.0000
SHI MAO 1.0000 –719.60 1.0000 0.7887 –10038.6 0.9934 0.7853 0.0000
BEI CHEN 0.6648 1.0000 0.4884 0.5578 1.0000 0.4884 0.5578 1.0000
Mean 0.6279 –75.94 0.4813 0.5958 –679.95 0.4138 0.6002 0.5455

Table 6. Correlations between bA0 and the efficiencies (no Table 7. Correlations between bA0 and the efficiencies (con-
consideration of OC). sideration of OC).
Model (10) Model (11) Model (13) Model (14)
Model (9) Model (12)
ea0 eca
0 ecp
0 ebia
0 ebip
0 ea0 eca
0 ecp
0 ebia
0 ebip
0
bA0 –0.467 –0.420 –0.138 –0.126 0.132 bA0 –0.485 –0.441 –0.133 –0.203 0.074

effort level from –0.6770 to 0:0876, and that of
GUANG YU changes from –0.8999 to 0:0113.
3. Comparing Table 5 with Table 4, we can
find that,
a. In Model (12), the efficiency of the TMT ea0
is larger than that in Model (9) slightly,
and the average effort level (75:94) is
lower than that (71:26) in Model (9).
Similarly in Model (13), the average
effort level (679:65) is also lower than
that (209:47) in Model (10). A possible
reason is that the risk-sharing between
TMT and the principal is inconsistent
and ratchet effect may diminish the
incentive mechanism (Holmstrom & i
Costa, 1986).
b. In bi-level programming, when the objectives
between the TMT and the principal are
consistent, the TMTs will often have the
incentive to improve their efficiencies by
exerting a higher level of the effort. For
example, the average efficiency increases
from 0:2850 to 0:4138, and the average
effort also increases from 0:3556 to
0:5455. However, the average efficiency
of the principal decrease from 0:6682 to
0:6002. A possible reason is that the prin-
cipal has to take the reaction of the TMT
into consideration when she makes deci-
sions (Van Ackere, 1993). In order to
achieve the incentive compatibility, the
principal has the motive to allow the
TMT to participate in the outcome
distribution.
4. We also find an interesting phenomenon: the
effort level bA0 in Model (11) is distributed more
evenly than that in Model (14). We might argue
that, under the leader-follower situation, the
reactions of the TMT’s effort are similar
when objective consistence is not considered,
and differ greatly when objective consistence
is considered.
Tables 6 and 7 show the correlations between the
efforts and the efficiencies.
1. In Models (9) and (12), the effort is significantly
negatively correlated with the TMT’s efficiency.
That is, a lower level of the effort is more
favourable to the TMT.
2. In Models (10) and (13), the effort is negatively
correlated with the efficiency of the TMT. That
is, in the cooperative situation, the TMT does
not concern more about the outputs of the
principal. He may choose a lower level of the
effort instead. In addition, the effort is weakly
negatively correlated with the efficiency of the
principal. It implies that the principal possibly
cannot observe the moral hazard of the TMT
(Mirrlees, 1999).
3. In Models (11) and (14), the effort is weakly
negatively correlated with the efficiency of
the TMT and is weakly positively correlated
with that of the principal. This demonstrates
that, in the leader–follower situation, both
parties will take the other’s reaction into

consideration and the TMT may enhance his
effort level. In particular, the effort shows a
slight influence on the efficiencies of
both parties.
7. Conclusions
TMT and his members play an increasingly central
role in modern companies under competitive busi-
ness environment. Prior research has emphasised
that the effort of the executives can have significant
impact on the performances of the principal and
TMT. However, the unobservable and immeasurable
characteristics of the effort results in uselessness and
inefficiency of various motivations by the principal.
In this paper, we develop an analytical framework
and propose models to measure the influence of
executives’ effort on the performances of the princi-
pal and TMT. We begin with two basic models to
identify the efficiency from the perspective of the
principal and TMT respectively, in which the two
parties are viewed as independent decision makers
and have different input–output bundles.
In an effort to depict various collaborations
between two parties, we propose integrated model
and bi-level programming to describe the coopera-
tive and leader–follower relationship respectively. In
addition, we innovatively characterise the effort level
as a variable in DEA context, which is similar to the
estimation of return to scale in BCC model. The
optimal value of the variable can implicitly signal
the relative level of the TMT’s effort and better
characterise its influence on the performances of the
two parties. Especially, the relationship between two
parties can also have significant impact on the effort
and performance of the TMT. We illustrate such
situation by characterising cooperative and princi-
pal-dominant relationship with integrated and bi-
level models. The TMT has the incentive to adjust
his effort level as a reply to various relationships.
Further, we portray potential and possible change
of the effort when the TMT encounters OC and
objective-inconsistent scenarios, which can help the
principal design incentive strategy under cooperative
and non-cooperative situations. Comparing with the
traditional DEA, our models provide a tool to
exposure the interaction between the two parties
within the system “black-box”.
Based on the approach, we have demonstrated
the availability of our models in a practical example:
real estate companies in China. The results show the
TMT may not work hard as the principal expects,
and the principal can design incentive contracts to
impel the TMT to induce higher effort level. Further
research includes exploration of our proposed mod-
els to many other potential applications in a great
JOURNAL OF THE OPERATIONAL RESEARCH SOCIETY 1023
deal of fields such as ecology, venture investment,
insurance industry and others.
The limitations of our models are also obvious.
Although the models work well in this case study
with a reasonably good data sample, the efficiency
scores assigned to each DMU may be sensitive to
sampling variations and the number of the DMUs is
limited compared to the number of variables. Future
research would consider whether efficiency gains
would be possible. These models can be extended to
consider the impact of the principal’s inputs on the
TMT’s efficiency and provide accurate measurement
for the effort. Moreover, we will further investigate
the impact of various inputs on the TMT’s
performance.
Disclosure statement
No potential conflict of interest was reported by
the author(s).
Statement of contribution
This paper formulates novel models to identify the agent’s
unobservable effort impact on the performances of the
principal and top management team. We begin with the
basic models from the perspective of the principal and
the top management team respectively, and propose inte-
grated and bi-level models to illustrate the cooperative
and leader–follower collaboration between two parties.
We then develop an effort-based DEA model in which
the effort of the top management team is viewed as a
variable. By comparing optimal value of the variable with
zero, we can identify whether the effort level is desired by
the principal. Further, we identify objective consistence
between two parties by incorporating the organizational
outcomes into the outputs of the top management team.
The main contributions of this paper are concluded as
follows. The analytical framework and models are devel-
oped to measure the efficiencies of the top management
team and the principal. Second, we innovatively charac-
terise the effort level as a variable in DEA context, which
is similar to the estimation of return to scale. Third, we
portray potential and possible change of the effort when
the TMT encounters objective-consistent (OC) and
objective-inconsistent scenarios, which can help the prin-
cipal design incentive strategy under cooperative and
non-cooperative situations.
Acknowledgement
The authors thank the annoymous reviewers for their
helpful comments. The authors are grateful to Professor
Joe Zhu for his suggestions and comments on earlier ver-
sions of the paper.
Funding
This work was supported by National Natural Science
Foundation of China (Grant nos. 71701102, 71671173,
71828101,), Foundation of Jiangsu Higher Education
Institutions of China (Grant nos. 17KJB120007), and
1024 L. ZHAO ET AL.
Major International (Regional) Joint Research Projects
(Grant no. 71520107002).
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2
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X
R X
K XI
Ur yrj  Wk skj þ Vi2 xij  0; j ¼ 1; :::; n
Appendix A. Optimal efficiency of the TMT r¼1 k¼1 i¼1

dominated by the principal Ur ; Vi2 ; Wk ; Vd1 ;  0; r ¼ 1; :::; R; i ¼ 1; :::; I;

On the basis of Model (4), in order to determine the opti- k ¼ 1; :::; K; d ¼ 1; :::; D (A.4)
mum efficiency of the TMT dominated by the principal
The optimum efficiency of the TMT is obtained from
(eL0 ), two situations are discussed as follows: pa
the optimum value e0 . Comparing Model (A.2) with
(1) Supposing that Wk is unique in Model (4), and if
Model (A.4), we can see that e0 is less than e0 0 because
pa pa
there exists a certain k satisfying Wk 6¼ 0, the efficiency of
Model (A.4) has additional constraints than Model (A.2).
the TMT is
We can obtain the optimum efficiency of the TMT domi-
X
K X
D nated by the principal based on Model (A.2) and Model
e0 0 ¼ maxW Wk sk0 =
pa
v1d ld0 (A.4), ie, eL0 ¼ e0  . Similarly, we can obtain the optimum
pa

k¼1 d¼1 efficiency of the TMT dominated by the principal when con-
X
K X
D (A.1) sidering the level of effort and objective consistence.
s:t:W Wk skj = v1d lkj  1; j ¼ 1; :::; n
k¼1 d¼1
W; Wk ; v1d  0; k ¼ 1; :::; K; d ¼ 1; :::; D Appendix B. Solution and algorithm of bi-
level DEA model
where W is thePmultiples of skj (k ¼ 1; :::; K).
Let t ¼ 1= Dd¼1 v1d ld0 , tv1d ¼ Vd1 , tW ¼ d, the trans- Before we start to formulate the problem, we briefly
formed model is introduce one background model: bi-level programming.
Denote x 2 X 2 Rn and y 2 Y 2 Rm as the decision
X
K
e0 0 ¼ maxd Wk sk0
pa variables corresponding to the first and second level,
k¼1 respectively. The general form of bi-level linear program-
X
K X
D ming can be formulated as follows:
s:t:d Wk skj  Vd1 ldj  0; j ¼ 1; :::; n
(A.2) min uðx ; y Þ ¼ c1 x þ d1y
k¼1 d¼1 
x 2X
X
D
Vd1 ld0 ¼1 s:t:A1 x þ B1y  b1
d¼1 min cðx ; y Þ ¼ c2 x þ d2y (B.1)

y 2Y
Vd1  0; d>0; k ¼ 1; :::; K; d ¼ 1; :::; D
s:t:A2 x þ B2y  b2
The optimum efficiency of the TMT is obtained from
the optimum value of e0 0  .
pa x  0; y  0
1026 L. ZHAO ET AL.

where c1 ; c2 2 Rn , d1 ; d2 2 Rm , b1 2 Re , b2 2 Rf , A1 2 Ren , where

B1 2 Rem , A2 2 Rf n , B2 2 Rf m .    
U W
We first reformulate our problem into the standard x ¼ 2 ; 
y ¼ 1 ;
linear bi-level programming form and then solve the lin-  V  V
ear bi-level programming using existing branch and 0 c1 ¼ 1Y0 T ; 0 0 ; d1 ¼ ð0;10Þ;
0 1
bound algorithms by Shi et al. (2006). Yj ; XjT
T
dSTj ; 0 0
B C B C
Model (7) can be reformulated to the following stand- A1 ¼ @ 0; X0T A; B1 ¼ @ dST0 ; 0 A; b1 ¼ @ 1 A;
ard linear bi-level programming form. T
0; X0 dS0 ; 0
T 1
     T 
  U W c2 ¼ ð00; 0Þ; d2 ¼ 1S0 ; 0 ;
min Y0T ; 0 2 þ ð 0; 0 Þ 1 0 1
V V Sj T ; LTj
 U    W 
0
 B C
s:t: Yj T ; XjT þ dSTj ; 0 0 A2 ¼ 0; B2 ¼ @ 0; LT0 A; b2 ¼ @ 1 A:
2
  V   V1 0; LT0 1
  U   W
0; X0T 2 þ dST0 ; 0 1  1
V
  V  Finally we get following linear programming problem
  U   W with one check condition.
0; X0T þ dST0 ; 0 1
V2  V 1 
  W bip
X
R
U e0 ¼ max Ur yr0
minð0; 0Þ 2 þ ST0 ; 0 1
   V  V r¼1 !
U  W X
R X
K XI
s:t:ð0; 0Þ 2 þ STj ; LTj 1 0 s:t: Ur yrj  d Wk skj þ Vi2 xij  0; j ¼ 1; :::; n
  V   V
U   W r¼1 k¼1 i¼1
ð0; 0Þ 2 þ 0; LT0 1  1 X
K X
I
V
  V  d Wk sk0 þ Vi2 xi0 ¼ 1
U   W k¼1 i¼1
ð0; 0Þ þ 0; LT0 1 X
K X
D
V2 V1
Wk skj  Vd1 ldj  0; j ¼ 1; :::; n
U; V ; V ; W  0; j ¼ 1; 2; :::; n
1 2
k¼1 d¼1
(B.2) XD
Vd1 ld0 ¼ 1
Here, Yj T ¼ ðy1j ; :::; yRj Þ, XjT ¼ ðx1j ; :::; xIj Þ,
d¼1
Sj ¼ ðs1j ; :::; sKj Þ,
T
Lj ¼ ðl1j ; :::; lDj Þ;U ¼ ðU1 ; :::; UR ÞT ,
T
 B1 þ v B2 
u w ¼ d2
V ¼ ðV1 ; :::; VI Þ, W ¼ ðW1 ; :::; WK Þ, V 1 ¼ ðV11 ; :::; VD1 Þ
2 2 2
Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R; i ¼ 1;
We employ the extended branch and bound algorithm
by Shi et al. (2006) to solve this linear bi-level program- u ; v ; w
:::; I; k ¼ 1; :::; K; d ¼ 1; :::; D  0 (B.4)
ming model. By applying Theorem 1 of Shi et al. (2006)
about the general BLP problem to our case, we have At each iteration, the check is made to see whether the
Theorem 1 as follows. following condition is satisfied.
 ðb1  A1 x  B1y Þ þ v ðb2  A2 x  B2y Þ þ w
u  y ¼ 0
Theorem 1. Denote u 2 Rp , v 2 Rq and w
 2 Rm as the
dual variables associated with constraints (7a), (7b), (7d) (B.5)
and (7e), a necessary and sufficient condition that ðx  ; y  Þ In Model (B.4), the optimal solutions which satisfy
solves the bi-level DEA problem (7) is the existence of equation (B.5) are the optimal solutions of Model (B.3).
(row) vectors u  , v  and w
  such that ðx  ; y  ; u
  ; v  ; w
 Þ Specifically, Model (11) and Model (14) can be solved in
solves: the same way.
X R
bip
e0 ¼ max
Ur yr0
r¼1 !
X
R X
K XI
s:t: Ur yrj  d Wk skj þ Vi xij  0; j ¼ 1; :::; n
2

r¼1 k¼1 i¼1

X
K X
I
d Wk sk0 þ Vi2 xi0 ¼ 1
k¼1 i¼1
X
K X
D
Wk skj  Vd1 ldj  0; j ¼ 1; :::; n
k¼1 d¼1
X
D
Vd1 ld0 ¼ 1
d¼1
 B1 þ v B2 
u w ¼ d2
 ðb1  A1 x  B1y Þ þ v ðb2  A2 x  B2y Þ þ w
u  y ¼ 0
Ur ; Vi2 ; Wk ; Vd1  0; r ¼ 1; :::; R; i ¼ 1; :::; I; k ¼ 1; :::; K; d ¼ 1; :::; D
 ; v ; w
u  0
(B.3)