What is the Principal-Agent problem? Give an example. Offer some suggestions for correcting the problem in the example you’ve given.

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Expert Solution

The Principal-Agent problem includes two parties that are principal and an agent. The Principal-Agent problem arises in the situation when the decision of one party that is the principal is taken by another party that is the agent. The problem in this situation occurs because the actions or decisions of the agent are not known by the principal. The decisions of the agent may not always be in the interest of principal and the principal cannot control or ensure that the agent acts according to the principal’s interests. The interest of the principal is not always prioritized by the agent whereas it may be in the interest of agent.

An example of a Principal-Agent problem is “too-big-to-fail” companies. These companies are considered as so big to the economy of the country that the government always tends to bail out these companies in case of any crises or irrespective of their action. In this case, the company is the agent and the government in the principal. This will create a problem of Principal-Agent. The company may not work according to the interest of the government and only consider its own interests.

The problem in the given example could be resolved by properly monitoring the actions and operations of these companies by the government. The proper monitoring of these companies will ensure that the companies does not takes actions according to their interests only.

Rahul Sunny answered 1 year ago

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