Question

Natalia owns 3 gyms and employs a manager for each of her gyms. She gave each manager a 5% stake in the ownership of the gyms. By doing so, Natalia can___________.

a) reduce adverse selection problems

b) reduce principal agent problems

c) reduce both principal agent problems and the lemon's problem

d) reduce the lemon's problem

Answer 1

The right answer is option B, that is, reduce principal agent problems. As we know, principal agent problem arises when one party agrees to work in favour of the other party that will lead to the risky activities as people who are involved in the risky activities will not have to bear the cost of those risky activities. Therefore, by giving each manager of 5% stake in the ownership of the gyms, Natalia provides an incentive to the managers to work efficiently and not involved in risky activities that will lead to the reduction in profits.