Principal Agent Problem

Topics: Principal-agent problem, Agent Pages: 4 (1617 words) Published: May 7, 2013
Principal Agent Problem
Running a business can be a tricky expenditure in today’s society. As we know a business can only be successful economically if they are bringing more money than they are putting out. Owners of businesses realize that positive economic profit is essential to the livelihood of their businesses. As with every business, employees are hired to do specific tasks that the owner assigns for them. However, with employees comes the responsibility of managing them. This is where a manager comes into the picture. A manager is hired so that he/she can control the operations so that the business can run smoothly and make money. After all the main goal of any manager should always be to maximize the value of the business they are working for. However, in businesses where the owner is not in the workplace the majority of the time a problem may naturally occur over time. This problem in question is the principal agent problem. If a principal agent problem rears its head the health of the business may be put into jeopardy.

To understand why the principal agent problem is such a severe issue one has to understand what it truly is and how it applies to a real life scenario. Principal agent problems typically occur when an owner is away from their business and has delegated full control to a manager. By delegating control an owner has given their trust to the manager. They fully expect a manager to maximize the value of their business to the upmost degree. After all maximizing the value of a business should be the number one goal of any manager. However, in cases where the owner is not around, the separation of the principal (owner) and the agent (manager) becomes evident. Supervision of the agent has become lost and personal interests may begin to take over. An agent (manager) may begin to perform actions that the principal (owner) does not want them to do. Theory of the firm states that managers should maximize value based on the constraints given to...

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