What does the principal agent problem refer to, and what is an example of it? In...

What does the principal agent problem refer to,

and what is an example of it? In your example, what

is something that the agent might do that would con

flict with the goals of the principal? What actions

could the principal take to try to prevent (or at l

east reduce) this problem

Expert Solution

Principal agent problem is the problem which occurs when the principal hire or appoint the agent on behalf of them for taking the decision and the decision taken by the agent are don't align with the ideas of the principal.

Ex: Share holders are the principal who appoints the management as agents on behalf of them to take decision. Management took some decisions which are not aligning with the views or ideas of share holders which leads to principal agent problem.

Agent may take any decision that will be having on impact on the principal negatively which lead to this problem.

Example: Management suddenly want to borrow excess money and expand its business where the probability of success and earning profits is less than 5% and the probability of getting huge loss in 95%. So here the share holders are facing negative impact due to management decisions.

So the principal always try to do control the agent by restricting him or removing him on behalf of him. The principal can even make the agent understand his views and stop him from taking those decisions. This are the ways the principal prevent this problem. Most of the cases if ihey can both can sit , talk and understand each other point of view the problem is solved.

Rahul Sunny answered 2 years ago

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