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Explain the difference between a principal and an agent. How does this difference create the ‘principal-agent problem.

CM

Claire Manning

Transcript

Explain the difference between a principal and an agent. How does this difference create the ‘principal-agent problem’?

References

  • Begg, D And Ward, D. (2007). Growth Strategies. In: Begg, D And Ward, D Economics For Business . 2nd Ed. Berkshire: Mcgraw-Hill Education. P. 169.
  • Image - First Slide - Harvard Business Manager (2011) Prinicpal - Agent Theory. [Online] Available at: http://www.harvardbusinessmanager.de/heft/artikel/grossbild-590966-1358447.html (Date Accessed: 22nd November 2011)
  • Begg, D And Ward, D. (2007). Growth Strategies. In: Begg, D And Ward, D Economics For Business . 2nd Ed. Berkshire: Mcgraw-Hill Education.
  • Wit and Meyer (2004). Strategy – Process, Content, Context – An International Prospect. 3rd Edition. London: Thomson Learning
  • International Energy Agency (2007) MIND THE GAP – Quantifying Principal-Agent Problems in Energy Efficiency, France, 2007. Stedi Media. [Online]. Available at: http://www.iea.org/textbase/nppdf/free/2007/mind_the_gap.pdf (Date Accessed: 22nd November 2011)
  • Image - Fourth Slide - WordWorkersWorkshop(2011) Bridges. [Online] Available at: http://www.woodworkersworkshop.com/resources/index.php?cat=420 (Date Accessed: 22nd November 2011)

Who are Principals and Agents?

"A Principal is a person who hires an Agent to undertake work on their behalf." Begg And Ward (2007:169).

An Agent is hired to pursue the Principals interests.

Who is the Principal? Who is the Agent?

  • Taxi Hire
  • Travel Agents
  • Home Insurance

Conclusion

  • Possible negatives with all solutions.
  • Gap needs to be bridged to bring Principal and Agent interests closer.
  • Solutions dependent on business type.

What are the differences?

Agents

Principals

  • Shareholders
  • Cash exchanged for Shares
  • Financial interest only
  • Profit Maximisation
  • Ownership of the company
  • Managers
  • Work (labour) exchanged for a salary
  • Little financial interest in the business
  • Personal perks. E.g. company car
  • Run the company day-to-day

Principal - Agent Problem

  • Conflict of interests

and incentives

  • Separation of ownership from control
  • Moral hazards
  • Agency costs
  • Relationship type

Possible solutions

  • Profit Sharing
  • Efficiency wages
  • Piece rate
  • Pay
  • More communication between Principals and Agents - change in relationship type.
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