Week 10- Incentive alignment Flashcards
Do agents have different goals and preferences to principals?
yes, The principal wants the agent to work on their behalf
which term is referred to as female and which male?
principal: female
agent Male
what two problems must the principal manage to avoid incentive conflict?
Adverse selection and moral hazard
In principal-agent theory how is adverse selection a problem?
the principal must decide which agent to hire
In principal-agent theory how is moral hazard a problem?
once hired, the principal must find a way to motivate the agent
what are agency costs?
the costs of addressing moral hazard and adverse selection
how can a principal reduce agency costs?
by gathering information on:
- the agent’s type (adverse selection)
- about the agent’s actions (moral hazard)
how can the principal gather info about the agent?
- running background checks on agents before they are hired
- monitoring agents behaviour while they are working
can incentive pay impose a risk on agents?
yes
give an example of how incentive pay imposes risk on agents
commission means a portion of an agents compensation is dependant on factors beyond the agents control eg. weather.
should agents be compensated for the extra risk involved in taking commission?
yes
give an advantage of centralising decision making (with the principal)
decisions are made by those with better incentives
give an advantage of decentralising decision making (with the agent)
decisions are made by those with better info
what should a business do if it centralises decision making?
find a way to transfer information to those making the decisions
what should a business do if it decentralises decision making?
strengthen the incentive compensation of the agents
