Principal-agent problem Guide, Meaning , Facts, Information and Description
The principal-agent problem in economics refers to the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent.Suppose that principal Adam hires agent Eve to manage his business. Adam's lack of information about how Eve does her job allows her to shirk work, embezzle, or to violate the contract in some other way. She may also interpret the contract in a way that is different from the way Adam does. Thus, Adam may not get what he "bargained for," so his enterprise may not be as profitable as hoped.
Since the contract is not self-enforcing (and it is too expensive to have the government enforce each and every contract), Adam must find some way to ensure that Eve does her job. This can involve monitoring (supervising) her or requiring her to post a bond that she surrenders if she violates the contract. (Thus hired contractors are often "bonded.") Eve can be motivated to cooperate with the contract by offering her a share of profit income. Alternatively, if Eve knows that she will suffer a cost from losing her job, the fear of not being rehired (or of being fired) can motivate her to act according to the contract. Finally, Eve may not want to break the contract if her goals are identical to Adam's. Most of these solutions to the principal-agent problem are incomplete.
The principal-agent problem is found in most employer/employee relationships, for example, when stockholders hire top executives of corporations. Many interpret the extremely high salaries of chief executive officers of U.S. corporations in these terms.
See also: governance
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