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Agency Theory

Agency Theory. BSAD 172 Information Economics. Agency Theory. The problem of motivating one party to act on behalf of another is known as the principal-agent problem Agency theory is a ubiquitous theory to explain transactions between self-interested parties with incongruent goals

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Agency Theory

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  1. Agency Theory BSAD 172 Information Economics

  2. Agency Theory • The problem of motivating one party to act on behalf of another is known as the principal-agent problem • Agency theory is a ubiquitous theory to explain transactions between self-interested parties with incongruent goals • Nobel "for their analyses of markets with asymmetric information" • George Akerlof, Michael Spence, Joseph Stiglitz

  3. Agency Problems • Principal selecting types of agents (“cherries” Vs “lemons”) • Adverse Selection (Hidden Information) • Agent has a greater quantity or quality of information about its characteristics and capabilities than the principal • Moral Hazard (Hidden Action) • Principal’s concerns that the seller may act opportunistically and reduce quality of its offering

  4. Solutions to Agency Problems • Information Asymmetry (Adverse Selection or Hidden Information) • Solutions: • Signals • Screening • Self-Selection • Fears of Agent Opportunism (Moral Hazard or Hidden Action) • Solutions: • Incentives • Monitoring • Signals

  5. Agency Theory in Employment Relationships • Employer as principal, employee as agent • Employer selecting high-quality employees • Employee signaling its quality • Performance monitoring difficult • Aligning Principal-Agent Interests • Performance pay (piece rates/commissions) • profit sharing • efficiency wages • agent posting a bond • fear of firing

  6. Agency Theory in Transaction Relationships • Agency Theory in “markets with hidden information” • A principal (buyer) hires an agent (seller) to deliver a product as promised in a timely manner • Hidden Information (Adverse Selection) • Ex-ante Seller and Product/Service Misrepresentation • Buyers cannot easily identify high-quality sellers • Hidden Action (Moral Hazard) • Ex-post Fraud, Shirking, Product Quality Deception • Buyers fear sellers will not deliver products as promised

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