The principal-agent theory , also principal-agent theory or agency theory (sometimes also called the principal-agent model ) is a model of the new institutional economics that comes from economics . However, this theory is also established in the social sciences, sociology and political science . The term principal-agent theory is derived from the original English term principal-agent theory and the corresponding principal-agent problem . The problem underlying the principal-agent theory is referred to as the principal-agent problem or the principal-agent dilemma .
The principal designates the client and the agent the commissioner. The latter usually has a knowledge advantage ( information asymmetry ), which can be used in different ways either to the benefit or to the disadvantage of the principal. It is also assumed that the interests of the principal and agent are not congruent. The theory offers a model to explain the actions of people in a hierarchy . In addition, it makes general statements on the drafting of contracts .
The theory was first discussed in an essay by Michael Jensen and William Meckling in 1976. Its main features go back to the theory of incomplete contracts , which was founded among others by Ronald Coase .
The principal-agent theory is based on economic subjects who are restricted in their decision-making, for example due to asymmetrical information distribution. They have only incomplete information when they are asked to judge the actions of others.
Furthermore, the parties involved are assumed to be opportunistic . In a broad definition, a principal-agent relationship occurs when the welfare of one party ( principal ) depends on the actions of another party ( agent ). According to a narrow definition, there is a client ( principal ) who entrusts a contractor ( agent ) with a task by mutual agreement for a fee. Since the two can pursue different goals, conflicts can arise.
In addition, risk appetites are taken into account: In principle, risk neutrality , risk aversion or risk appetite is possible on both sides . This depends on the character traits and the respective situation of the actors.
The principal instructs the agent in the hope that the agent will do its job for the principal. However, he can only recognize the commitment and / or the qualities of his agent with limitations and sees - if at all - only the result of his efforts. In contrast, the agent has an information advantage, as he knows his own quality better and can determine his own behavior and judge it accordingly. He will exploit this information asymmetry to the detriment of the principal if this serves his own purposes ( moral risk and shirking ).
Various types of problems can cause disturbances in the principal-agent relationship. Their elimination leads to agency costs . These are made up of the costs for signaling , screening and the remaining loss of welfare between the best possible and the existing solution. These agency costs must not exceed the existing loss of welfare, otherwise the actions of the parties would be classified as inefficient. The problems that arise between principal and agent can be roughly categorized into adverse selection , moral risk and hold-up .
A first problem relates to the field hidden properties (engl. Hidden characteristics ) and the resulting risk of adverse selection . Before the contract is signed ( ex ante ), the agent may be relatively unknown to the principal. The principal could have chosen the wrong applicant as agent due to lack of knowledge of the characteristics. To avoid this, the agent must send clear signals that cannot be imitated by any worse competitor (“ signaling ”). These signals should prove the trustworthiness, efficiency, affiliation to a certain market segment, to a subculture with shared values or a certain status group. Signaling strategies are often complex, resource-intensive or even wasteful and thus seem economically irrational. However, under the conditions of incomplete information about the market, its actors and their capabilities, this behavior can be explained with the advantages that can be achieved, e.g. B. with the reduction of search times and effort in the selection of employees. Certificates are used for this purpose. The principal can also remedy this information deficit by carrying out a so-called “ screening ” (e.g. through selection in an assessment center ). He himself also has to send appropriate signals in order to show his attractiveness as an employer.
Another solution to the problem arises through " self-selection " in that he presents the agent with several contracts, between which the agent can choose. From the selection made by the agent, the principal can draw a conclusion about possible strategies of the agent.
Conversely, an actual agent can come across a principal with hidden properties. An example would be the relationship between a worker and a building contractor who does not pay foreign workers or does not pay them in full. In this case, a double, opposing principal-agent relationship arises. In terms of the nature of his work, the construction worker is an agent towards the building contractor (principal). However, if one looks at the contractor's payment obligations, he is an agent towards the foreign worker. The contractor could, for example, withhold information from the foreign construction worker about the right to a minimum wage or otherwise defraud him of his due payment.
Hidden action and hidden information
The problem types covert action ( hidden action ) and hidden information ( hidden information ), however, the contact information asymmetries only ex post , ie after the conclusion and during performance of the contract on. Hidden action means that the agent has discretionary leeway, since the principal cannot (completely) observe his actions. Hidden information, on the other hand, exists when the principal observes the actions, but cannot assess their quality (e.g. due to a lack of specialist knowledge).
In both cases there is a moral risk . The problem is based on the fact that the principal cannot assess, even ex post, whether the result was achieved through qualified efforts of the agent or whether (or how much) the environmental conditions influenced the result.
Even if the principal has the opportunity to observe the agent's actions, i.e. if there is no hidden action or hidden information, problems can still arise in certain cases because the principal does not know the intentions of the agent ex ante. This is called hidden intention ( hidden intention referred). As a result, a hold-up problem can arise.
With exchange goods, only hidden properties can be a problem, with contract goods, on the other hand, hidden information and hidden action represent a potential danger.
Optimization for asymmetrical information
The principal-agent theory is based on asymmetric information. Therefore, the best solution that would theoretically be conceivable in the case of symmetrical information is not given. If one therefore assumes asymmetrical information and the information deficiencies are not corrected, only a third-best solution can be achieved. The aim must therefore be to achieve at least a second-best solution for the given lack of information. However, agency costs must be raised for this.
Attempts are made to mitigate or even remedy the principal-agent problem using the following mechanisms:
- Bureaucratic control ( hierarchy )
- Information systems (controlling, time recording, milestones)
- Incentives ( incentives , bonuses; see also incentive system )
- Corporate culture
Systems that give the agent an incentive to behave correctly are particularly effective. A performance-based reward aligns the agent's goals with the principal's goals. A distinction is made between several incentive systems:
- The “all or nothing” principle, whereby the agent is only rewarded for a specific result
- Lease, whereby the agent gives a fixed amount to the principal and may keep a surplus if necessary
- Fixed wage, whereby the agent is paid regardless of the result (no incentive)
- Share cropping, where the profit is proportionally shared between the principal and the agent.
Each of the systems has its strengths and weaknesses in terms of risk distribution, incentive intensity and control effect.
A corporate culture can lead to a reduction in agency costs. Similarities in preferences, values, goals and competencies minimize coordination costs. This facilitates mutual coordination and learning. The efficiency aspects dominate, but they are undermined by the homogeneous culture: In homogeneous cultures, long-term relationships often lead to transaction-specific investments that increase dependencies and allow the weaker to be exploited and to behave opportunistically.
Reputation can be interpreted as specific capital that needs to be defended the more opportunities there are for opportunism . A good reputation lowers the incentive to behave opportunistically and for this reason it lowers information and negotiation costs (ex ante).
An example is the employment relationship, in which the employee ( agent ) knows better how hard he is working for his employer ( principal ). The principal-agent theory seeks to find ways out of these conflicts in order to maximize the overall economic benefit of all parties involved. In the example of the employee, the employer can either monitor the employee's work or pay him based on success in order to defuse the conflict of interest between the contractual partners ( interest alignment ). Another alternative would be to risk losing one's job in the event of a breach of contract. Building contractors are often bound to the contractual agreements by means of a bond .
The principal-agent theory is one of the leading explanatory approaches that are discussed and applied in economics today, alongside the transaction cost theory , the theory of rights of disposal and the resource theory .
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