Blackwell Reference Online

Extract

The general problem of motivating one person or organization to act on behalf of another is known as the principal–agent problem. The principal–agent problem arises when the principal hires an agent to perform tasks on her behalf and the agent thereby influences the welfare of the principal. The principal–agent relationship provides a useful framework for analyzing situations in which there is asymmetric information and when there is a need to design a contract ( see contracts ) or monitor the behavior of parties. moral hazard and adverse selection are also examples of the principal–agent problem. For example, a typical firm is owned by shareholders (principals) who hire professional managers (agents) to run the company. The manager may be more interested in maximizing the firm's market share, size, and growth in order to provide her and her subordinates greater opportunities for promotion. Furthermore, managers may prefer to make investments whose payoffs come earlier rather than later, avoid risks, shirk, and otherwise fail to maximize the profits of the firm. Although economists commonly assume profit maximization when we describe the decision‐making of a firm, the incentives of managers often differ from those of the shareholders and the efforts of the managers are impossible or too expensive to monitor. This would not be a problem if an enforceable contract could be ... log in or subscribe to read full text