Week 10

Question 1

Principal-agent problem

Answer 1

A principal wants an agent to act on her behalf. But agents often have different goals and preferences than do principals.

Question 1

Incentive conflict

Answer 1

Because the agent has different incentives than the principal, the principal must manage the incentive conflict, which comes down to two problems with which you will by now be familiar:
Adverse selection: the principal has to decide which agent to hire
Moral hazard: once hired, the principal must find a way to motivate the agent.
- caused by asymmetric information

Question 2

Agency costs

Answer 2

A principal can reduce agency costs if she gathers information (reduces information asymmetry)
about the agent’s type (adverse selection); or
about the agent’s actions (moral hazard).