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Basic idea of agency theory. The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity (the "agent") takes actions on behalf of another person or entity (the "principal"). [1] The problem worsens when there is a greater discrepancy of interests and information between the principal ...
Multiple principal problem. The multiple principal problem, also known as the common agency problem, the multiple accountabilities problem, or the problem of serving two masters, is an extension of the principal-agent problem that explains problems that can occur when one person or entity acts on behalf of multiple other persons or entities. [1]
In modern contract theory, "adverse selection" characterizes principal-agent models in which an agent has private information before a contract is written. [23] [24] For example, a worker may know his effort costs (or a buyer may know his willingness-to-pay) before an employer (or a seller) makes a contract offer.
Information asymmetry. Diagram illustrating the balance of power with perfect information by buyers and sellers. In contract theory, mechanism design, and economics, an information asymmetry is a situation where one party has more or better information than the other. Information asymmetry creates an imbalance of power in transactions, which ...
Agency cost. An agency cost is an economic concept that refers to the costs associated with the relationship between a "principal" (an organization, person or group of persons), and an "agent". The agent is given powers to make decisions on behalf of the principal. However, the two parties may have different incentives and the agent generally ...
Holmström is particularly well known for his work on principal-agent theory. His work made seminal advances in understanding contracting in the presence of uncertainty. [6] More generally, he has worked on the theory of contracting and incentives especially as applied to the theory of the firm , to corporate governance and to liquidity ...
Such a situation runs counter to neo-classical economic theory. The neo-classical market is instantaneous, forbidding the development of extended agent-principal (employee-manager) relationships, planning, and of trust. Coase concludes that “a firm is likely therefore to emerge in those cases where a very short-term contract would be ...
Jensen and Meckling (1976), Mirrlees (1976), Ross (1973), and Stiglitz (1975) were the key theorists who initiated the original theories of principal-agent theory. The principal-agent theory, often discussed in the context of corporate governance and contract theory, examines how bargaining power is distributed between principals (e.g., shareholders) and agents (e.g., managers).