Question

What is the principal-agent problem?A) It is a problem of the power system of boss and subordinate where the boss (principal) exerts influence over his subordinates (agents) using punishment or threat.B) It is a problem that exists when a person (principal) has more information about the task than the agent he hires to perform the task.C) It is a problem caused by a person (principal) who hires an agent to act on his behalf but is unwilling to delegate authority to the agent to carry out the task in the best possible way.D) It is a problem caused by agents pursuing their own interests rather than the interests of the principals who hired them.

Answer 1

Answer: The correct answer is D) It is a problem caused by agents pursuing their own interests rather than the interests of the principals who hired them.

Explanation: A principal in the context of a business is the owner of the business which in most cases are the shareholders. While the agents are those employed or hired to engage in the day to day activities of the business.

The principal most often aims to maximise shareholders wealth. Principal- agent problem may arise where the agent s of the business put their interests as priority as against the interests of the principal. Such interests of the agents may be to earn bonuses even if it would jeopardize the growth of the organisation.This is an ineffective way of running an organization.