Incentive Theory of the Third Sector of Economy (Non-Profit Organization)


1 University of Isfahan, Faculty of Administrative sciences and Economics

2 Assistant Professor, University of Isfahan, Faculty of Administrative sciences and Economics


This article aims to provide theoretical model for analyzing challenge of asymmetric information in the third sector of economy (which is the most important challenge, preventing the growth and development of third sector), using the theoretical foundation of contract theory and incentive theory with regard to the special characteristics of third sector derived by its special structure in Iran. For this purpose, we introduce a conceptual model that provides a new methodology for analyzing contract theory in the third sector, and offer the optimal contract in every transaction and state. To this end, we put forward the transactional segments of asymmetric information and the possibility of adverse selection and moral hazard problems. Then we provide a general incentive theory for the third sector of economy. As a result, it provides a mathematical and theoretical model for optimal contract and makes contribute to solve the adverse selection and moral hazard problems in the third sector transactions. Eventually, we use experimental analysis (lingo software) to show that mathematical model is solvable.  Afterwards we calculate the list of optimal contracts with hypothetical prompters. Field study in Iran (Isfahan) shows that the effect of solving asymmetric information problem is about 73% in the scale of third sector of economy which is significant and notable.



Benabou, R., & Tirole, J. (2003). Intrinsic and Extrinsic Motivation. The Review of Economic Studies70(3), 489-520.

Bolton, P., & Dewatripont, M. (2005). Contract Theory. Cambridge, Massachusetts: MIT Press.

Brousseau, E., & Glachant, J. M. (2002). The Economics of Contracts: Theories and Applications. Cambridge: Cambridge University Press.

Frey, B. S. (1994). How Intrinsic Motivation is Crowded Out and In. Rationality and society6(3), 334-352.

Hansmann, H. (1980). The Role of Nonprofit Enterprise. Yale Law Journal, 89, 835-901.

Hopt, K. J., & Von Hippel, T. (2010). Comparative Corporate Governance of Non-Profit Organizations. Cambridge: Cambridge University Press.

Kreps, D. M. (1997). Intrinsic Motivation and Extrinsic Incentives. The American Economic Review, 87(2), 359-364.

Laffont, J. J., & Martimort, D. (2009). The Theory of Incentives: The Principal-Agent Model. Princeton, New Jersey: Princeton University Press.

Ortmann, Andreas. (1996). Modem Economic Theory and the Study of Nonprofit Organizations: Why the Twain Shall Meet. Nonprofit and Voluntary Sector Quarterly, 25, 470-484.

Speckbacher, G. (2013). The Use of Incentives in Nonprofit Organizations. Nonprofit and Voluntary Sector Quarterly42(5), 1006-1025.

Steinberg, R. (2010). Principal-Agent Theory and Nonprofit Accountability. In K. J. Hopt & T. Von Hippel (Eds.), Comparative Corporate Governance of Non-profit Organizations, Working Paper, Retrieved from

Steinberg, R., & Bradford, G. (1993). The Role of Nonprofit Enterprise in 1992, Hansmann Revisited. Nonprofit and Voluntary Sector Quarterly, 22, 297-316.

Weisbrod, Burton. (1975). Toward a Theory of the Voluntary Nonprofit Sector in a Three-Sector Economy. Phelps, E. S. (Ed.): Altruism, Morality, and Economic Theory Journal, Retrieved from