Editing Principal–agent problem (section)

{{Short description|Conflict of interest when one agent makes decisions on another's behalf}}
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[[Image:Principal–agent problem variantion 1.svg|thumb|320px|right|Basic idea of agency theory]]
The '''principal–agent problem''' refers to the conflict in interests and priorities that arises when one person or entity (the "[[Agent (economics)|agent]]") takes actions on behalf of another person or entity (the "[[Principal (commercial law)|principal]]").<ref>{{Citation | last = Eisenhardt | first = K.M. | year = 1989 | title = Agency Theory: An Assessment and Review | journal = The Academy of Management Review | volume = 14 | number = 1 | pages = 57–74 | jstor = 258191 | doi = 10.5465/amr.1989.4279003 }}.</ref>  The problem worsens when there is a greater discrepancy of interests and information between the principal and agent, as well as when the principal lacks the means to punish the agent.<ref>{{Cite journal |last=Adams |first=Julia |date=1996 |title=Principals and Agents, Colonialists and Company Men: The Decay of Colonial Control in the Dutch East Indies |url=https://www.jstor.org/stable/2096404 |journal=American Sociological Review |volume=61 |issue=1 |pages=12–28 |doi=10.2307/2096404 |jstor=2096404 |issn=0003-1224 |access-date=September 16, 2022 |archive-date=September 20, 2022 |archive-url=https://web.archive.org/web/20220920174719/https://www.jstor.org/stable/2096404 |url-status=live |url-access=subscription }}</ref> The deviation from the principal's interest by the agent is called "[[agency cost]]s".<ref name="Bebchuk">''Pay Without Performance'', Lucian Bebchuk and Jesse Fried, Harvard University Press 2004 ([http://www.pay-without-performance.com/Preface%20and%20Introduction.pdf preface and introduction] {{Webarchive|url=https://web.archive.org/web/20190214170123/http://www.pay-without-performance.com/Preface%20and%20Introduction.pdf |date=February 14, 2019 }})</ref>

Common examples of this relationship include [[corporate management]] (agent) and shareholders (principal), [[Representative democracy|elected officials]] (agent) and [[citizens]] (principal), or brokers (agent) and markets (buyers and sellers, principals).<ref>{{cite web |url= http://www.investopedia.com/terms/a/agencycosts.asp |title= Agency Costs |work= Investopedia |access-date= July 3, 2012 |archive-date= April 22, 2019 |archive-url= https://web.archive.org/web/20190422120846/https://www.investopedia.com/terms/a/agencycosts.asp |url-status= live }}</ref> In all these cases, the principal has to be concerned with whether the agent is acting in the best interest of the principal. Principal-agent models typically either examine [[moral hazard]] (hidden actions) or [[adverse selection]] (hidden information).<ref>{{Citation |last=Gailmard |first=Sean |title=Accountability and Principal–Agent Theory |date=2014 |url=http://dx.doi.org/10.1093/oxfordhb/9780199641253.013.0016 |work=The Oxford Handbook of Public Accountability |publisher=Oxford University Press |first4=Sean|doi=10.1093/oxfordhb/9780199641253.013.0016 |isbn=978-0-19-964125-3 |url-access=subscription }}</ref>

The principal{{ndash}}agent problem typically arises where the two parties have different interests and [[information asymmetry|asymmetric information]] (the agent having more information), such that the principal cannot directly ensure that the agent is always acting in the principal's best interest, particularly when activities that are useful to the principal are costly to the agent, and where elements of what the agent does are costly for the principal to observe.

The agency problem can be intensified when an agent acts on behalf of multiple principals (see [[multiple principal problem]]).<ref name= "Voorn">{{Cite journal|title = Multiple principals, multiple problems: Implications for effective governance and a research agenda for joint service delivery |url = https://www.researchgate.net/publication/330541442 |journal = Public Administration |volume = 97 |issue = 3 |pages = 671–685 |date = 2019 |doi = 10.1111/padm.12587| last1 = Voorn | first1 = B. | last2 = Van Genugten | first2 = M. | last3 = Van Thiel | first3 = S.|doi-access = free |hdl = 2066/207394 |hdl-access = free }}</ref><ref>{{Cite book |last=Downes |first=Alexander B. |url=https://www.worldcat.org/oclc/1252920900 |title=Catastrophic success : why foreign-imposed regime change goes wrong |publisher=Cornell University Press |year=2021 |isbn=978-1-5017-6116-4 |oclc=1252920900}}</ref>  When multiple principals have to agree on the agent's objectives, they face a [[collective action problem]] in governance, as individual principals may lobby the agent or otherwise act in their individual interests rather than in the collective interest of all principals.<ref name= "Bernheim">{{Cite journal |title = Common agency |journal = Econometrica: Journal of the Econometric Society |date = 1986| last1 = Bernheim | first1 = B.D. | last2 = Whinston | first2 = M.D.|volume = 54 |issue = 4 |pages = 923 |doi = 10.2307/1912844 |jstor = 1912844 }}</ref> The multiple principal problem is particularly serious in the public sector.<ref name= "Voorn"/><ref name= "Martimort">{{Cite journal |title = The multiprincipal nature of government |journal = European Economic Review |volume = 40 |issue = 3–5 |pages = 673–85 |date = 1996 |doi = 10.1016/0014-2921(95)00079-8 | last = Martimort | first = D.}}</ref><ref name="Moe">{{Cite journal|title = Power and political institutions |journal = Perspectives on Politics|volume = 3 |issue = 2 |date = 2005 |doi = 10.1017/S1537592705050176 | last = Moe | first = T.M.| doi-broken-date=December 9, 2024 |s2cid = 39072417}}</ref>

Various mechanisms may be used to align the interests of the agent with those of the principal. In employment, employers (principal) may use [[piece rates]]/[[Commission (remuneration)|commissions]], [[profit sharing]], [[efficiency wages]], [[performance measurement]] (including [[financial statements]]), the agent posting a bond, or the threat of termination of employment to align worker interests with their own.