Friday, November 11, 2016

The Principle-Agent problem

The Principle-Agent problem means the motivation of one party (usually the agent) to act on behalf of another (the principal). Agency problems arise in a variety of different contexts, and arise when the incentives between the agent and the principal are not perfectly aligned and conflicts of interest arise. As a result the agent may be tempted to act in his or her own interest rather the principal’s. Conflicts of interest are almost inevitable.

One of the famous example that pops out of my mind is the Enron scandal revealed in 2001, which eventually led to the bankruptcy of the Enron Corporation and the dissolution of Arthur Anderson. Enron's board of directors, many analysts believe, failed to carry out its regulatory role in the company and rejected its oversight responsibilities, causing the company to venture into illegal activity. Company leadership, including boards of directors and the executive team, does not necessarily have the same interests as shareholders. It is believed that a lack of alignment between shareholders and directors may be the final cause of Enron’s demise.

However, as the prompt states, the situation in reality is often more like a triangle- the agent deals with two different principals. Speaking of which, I would like to share my own experience. When my freshman year was over, I went back to China. During the summer, I was employed by an English teaching agency. My job was to teach in an English boost camp for middle school student. The size of the class was not big (around 20-25 people), and students came to the agency on a daily base. The class was supposed to design to improve students’ test results and overall English skills. Thus, the agendas were basically focused on doing exercises and analyzing them. Here are some examples of the exercises that were related to the test: 

As we can tell, English tests in China concentrate a lot in grammar. Grammar is actually very boring. I bet not a lot of English speaker can say confidently that they were good at grammar correction. When I followed the agendas, and use most of the class time in asking students to finish the exercises, I found out lots students actually show passive attitude. They told me that they didn’t have any interest in learning English, and hoped that I could help them. Personally, I always think English skill is based on vocabulary levels. Language is used to communicate, and as long as the initiator and receiver understand each other, emphasizing too much on grammar will make no sense. Therefore, I rearranged the agenda, and put most of the in teaching students new vocabulary by playing interesting videos, movies, and discussing society hot topics.
Gradually, students started showing positive feedback. Nonetheless, my supervisor didn't agree with my teaching concept and asked me to change it back to the original one. He told me that what I was doing couldn’t improve students’ abilities to take exams. I then had an argument with him. Because I believed that English skills were not only limited to taking exams. English skills were more about expressing one’s thoughts, understanding other’s conversation, and starting appreciating its beauty. None of us chose to back up, and I ended up getting fired.

I think there definitely are more than one way to resolve such tension. But the choices are depending on the negotiation. I am aware that in the economic world, regulations are often used to solve principal- agent problem. Nevertheless, after reading Gary J. Miller’s “Solution to Principal-Agent Problems in firms”, I agreed with Miller’s opinion that there is no unique “solution” to the principal-agent problems in a firm. Instead, a Coasean “contingency” theory can be constructed in which different conditions inside the firm (characterized by production technology, severity of information asymmetry, and relative risk-preferences of principals and agents) call for different “solutions” to the principal-agent problems.