3.1 - Principal Agent

Question 1

What is the primary cause of the principal agent problem?

Answer 1

Asymmetric information

Question 2

What does the principal agent problem entail?

Answer 2

Owners cannot directly observe/oversee day to day management decisions
An ‘Agent’ is hired to do so in their place

Question 3

How does the principal agent problem become a problem?

Answer 3

Principal + agent have different experiences
Principal + agent have different priorities
Agent difficult + costly to monitor

Question 4

Which roles do the principal and agent represent within a firm?

Answer 4

Principal - Owner/General Manager
Agent - Sales/Finance Manager

Question 5

How can the principal agent problem be overcome?

Answer 5

Long term contracts for senior management
Long term stock commitment
Employee share ownership schemes

Question 6

How can long term contracts counteract the principal agent problem?

Answer 6

Security of tenure encourages managers to make pricing/financing decisions in the long term best interest of the business