iHeavy Insights 60 – Principal Agent

Principal Agent

by Sean Hull

The principal agent problem is a dilemma in economics. It occurs when a principal hires an agent to provide a service while both their interests are not aligned. It is further compounded when there is so-called asymmetric information.

For example, when you go to a car mechanic because your car is behaving strangely, you may know very little about automobiles other than how to drive them. In this case the mechanic has asymmetric information, ie he or she understands much better what’s happening under the hood. The interests being misaligned comes in because your interest is to pay the lowest price, while his interest is to sell the most hours of labor, and parts.

These days we’re digging through the rubble of the financial meltdown of last fall, and economists are talking about this principal agent problem. Agents hawking funds invariably have better information about what funds are good and which ones not so good, and their interests are not often aligned with their clients.

The Economist spoke with Adair Turner, head of the UK Financial Services Authority who referred to some banking activities as “socially useless” while others were “socially useful”. Indeed it’s an interesting way to look at the question.

Hopefully we can then make a small jump to discussing IT consulting, and professional services. We see the principal agent problem often. Economists suggest applying such things as profit sharing, higher compensation for efficiency and performance measurement. All of these are fine and good and may well go some way towards resolving the problem.

However I would argue there are two fundamentals that are worth pursuing. One is to up the information asymmetry, ie do your homework to learn more about the services being rendered, and the details of what tasks are being performed. Ask questions, perform due diligence, and ask other providers for their take on the problem.

Secondly I would argue that trust is important. You want to build up some trust with a provider, and that means relationship building. That’s the age-old balm for good business. Have an open mind, keep your interests and that of your provider in the front of your mind, be aware how they align, and when and if they don’t and continue to discuss those issues. Through that type of dialog you can better come to a common ground. Also as time passes, the relationship and history of good will can bring confidence to both parties.

So to conclude, I would suggest that the principal agent problem remains in many areas of business, and that correcting the asymmetric information problem will go some way towards resolving it, but that a good relationship built on trust from both parties is in the end the best medicine for business.

Review: The 50th Law

by 50 Cent & Robert Greene

Robert Greene is the acclaimed author of 48 Laws of Power, and 33 Strategies of War. His new book chronicles 50 Cent’s rise to fame through adversity and against all odds.

He mixes many of the themes from his previous works, with real life illustrations from 50 Cent’s life. I found it to be a good read, full of excellent lessons on personal and career development, focus, strength and perseverance.

View The 50th Law