Editing Principal–agent problem (section)

== Economic theory ==
In economic theory, the principal-agent approach (also called agency theory) is part of the field ''[[contract theory]]''.<ref name="Laffont-2002">{{Cite book|title = The theory of incentives: The principal-agent model|last1 = Laffont|first1 = Jean-Jacques|publisher = Princeton University Press|year = 2002|last2 = Martimort|first2 = David}}</ref><ref>{{Cite book|title = Contract theory|last1 = Bolton|first1 = Patrick|publisher = MIT Press|year = 2005|last2 = Dewatripont|first2 = Matthias}}</ref> In agency theory, it is typically assumed that complete contracts can be written, an assumption also made in [[mechanism design]] theory. Hence, there are no restrictions on the class of feasible contractual arrangements between principal and agent.

Agency theory can be subdivided in two categories: (1) In [[adverse selection]] models, the agent has private information about their type (say, their costs of exerting effort or their valuation of a good) ''before'' the contract is written. (2) In [[moral hazard]] models, the agent becomes privately informed ''after'' the contract is written. Hart and Holmström (1987) divide moral hazard models in the categories "hidden action" (e.g., the agent chooses an unobservable effort level) and "hidden information" (e.g., the agent learns their valuation of a good, which is modelled as a random draw by nature).<ref>{{Cite book|title = Advances in Economics and Econometrics|last1 = Hart|first1 = Oliver|publisher = Cambridge University Press|year = 1987|pages = 71–155|last2 = Holmström|first2 = Bengt|editor-last = Bewley, T.|chapter = The theory of contracts}}</ref> In hidden action models, there is a stochastic relationship between the unobservable effort and the verifiable outcome (say, the principal's revenue), because otherwise the unobservability of the effort would be meaningless. Typically, the principal makes a take-it-or-leave-it offer to the agent; i.e., the principal has all bargaining power. In principal–agent models, the agent often gets a strictly positive rent (i.e. their payoff is larger than their reservation utility, which they would get if no contract were written), which means that the principal faces agency costs. For example, in adverse selection models the agent gets an information rent, while in hidden action models with a wealth-constrained agent the principal must leave a limited-liability rent to the agent.<ref name="Laffont-2002" /> In order to reduce the agency costs, the principal typically induces a second-best solution that differs from the socially optimal first-best solution (which would be attained if there were complete information). If the agent had all bargaining power, the first-best solution would be achieved in adverse selection models with one-sided private information as well as in hidden action models where the agent is wealth-constrained.

Contract-theoretic principal–agent models have been applied in various fields, including financial contracting,<ref>{{Cite book|title = The theory of corporate finance|last = Tirole|first = Jean|publisher = Princeton University Press|year = 2006}}</ref> regulation,<ref>{{Cite journal|title = Regulating a Monopolist with Unknown Costs|jstor = 1912769|journal = Econometrica|volume = 50|issue = 4|pages = 911–930|doi = 10.2307/1912769|first1 = David P.|last1 = Baron|first2 = Roger B.|last2 = Myerson|date = 1982|citeseerx = 10.1.1.407.6185}}</ref> public procurement,<ref>{{Cite journal|title = Public procurement in times of crisis: The bundling decision reconsidered|journal = Economics Letters|date = 2013|pages = 533–536|volume = 121|issue = 3|doi = 10.1016/j.econlet.2013.10.015|first = Patrick W.|last = Schmitz|doi-access = free}}</ref> monopolistic price-discrimination,<ref>{{Cite journal|title = Monopoly with Incomplete Information|last1 = Maskin|first1 = Eric|date = 1984|journal = RAND Journal of Economics|last2 = Riley|first2 = John|pages = 171–196|volume = 15|issue = 2|jstor = 2555674}}</ref> job design,<ref>{{Cite journal|title = Job design with conflicting tasks reconsidered|journal = European Economic Review|date = 2013|pages = 108–117|volume = 57|doi = 10.1016/j.euroecorev.2012.11.001|first = Patrick W.|last = Schmitz|doi-access = free}}</ref> internal labor markets,<ref>{{Cite journal|title = Internal labor markets and worker rents|journal = Journal of Economic Behavior & Organization|date = 2012|pages = 491–509|volume = 84|issue = 2|doi = 10.1016/j.jebo.2012.08.008|first1 = Matthias|last1 = Kräkel|first2 = Anja|last2 = Schöttner|citeseerx = 10.1.1.320.692}}</ref> team production,<ref>{{Cite journal|title = Moral hazard in teams|last = Homström|first = Bengt|date = 1982|journal = Bell Journal of Economics|doi = 10.2307/3003457|pages = 324–340|volume = 13|issue = 2|jstor = 3003457}}</ref> and many others.
From the [[cybernetics]] point of view, the Cultural Agency Theory arose in order to better understand the socio-cultural nature of organisations and their behaviours.