A principal-agent (P-A) model is used to analyze the effect of environmental diligence, the principal (top management), having to use imperfect performance indicators and fearing penalties for environmental damages, wants to avoid environmental harm and induce the agent (employee manipulating hazardous materials) to take appropriate action. To motivate the agent, the principal offers an incentive contract based on environmental stewardship performance (as measured by EPI). Environmental stewardship being difficult to measure, due to high levels of uncertainty surrounding, EPI, creates impediments to the establishment of an efficient P-A contract.

Reprinted with Permission from Springer's Open Choice