Question

You are the owner of a clothing retail store in Manhattan that sells brand name clothes, including high-end clothing brands. Your retail salespersons are paid a mean hourly wage of $15. Over the last several months, your sales have significantly declined and customer satisfaction surveys indicate that your customers are increasingly dissatisfied with the quality of service. You just took a course in microeconomics for business decisions in which you learned about the concept of principal-agent problem. To what extent should you apply this concept to increase the motivation of your retail salespersons? How should the performance of the retail salespersons be evaluated? Should you redesign the structure of compensation in terms of fixed pay (hourly wage) and variable pay (bonus, commissions)? . Please add something about principal agent problem , thanks

Answer 1

Principal agent problem or agency problem refers to the scenario when management people or employees have different objectives to that of the owners. Here, the top executives, management or employees work as an agent of the owners, but work for their own benefits, rather the benefits of the owners who have employed them. So, an agency problem is created.
By applying the concepts, I would synchronize the objectives of these salespeople with the objectives of the organization. It will happen when the employee compensation, benefits and other perks are linked to the profits earned by the organization. So, higher profits earned by the organization will drive the compensation earned by these salespeople. It will improve the morale and employees will think to improve their performance to get higher compensation.

Performance of the sales person will be evaluated on the following metrics:
1.   Number of conversions and business development done by the each sales person
2.   Total contribution to the profitability
3.   Customer feedback about the salesperson, his friendliness and products being shown to them by the salesperson
4.   Follow up of the guidelines of the organization

Yes, I would like to redesign the compensation. It should have variable as well as fixed portion of the compensation. Fixed part should depend upon the pay scale or the salary band. Variable compensation should be dependent upon the business development and other positives brought in by the employees. As a long term incentive, stock options should also be issued to the employees so that ownership feeling and motivation is developed among the employees. It will largely eliminate the agency problem.