The Principle/Agent Problem and Moral Hazard

1
The Principle/Agent Problemand Moral Hazard

• Prof. Phillip J. Bryson
• Marriott School of Management

2
Moral Hazard

• Moral hazard is the form of
• postcontractual opportunism
• that arises because actions that have efficiency
  consequences are not freely observable
  (monitoring problem)
• so the person taking them may choose to pursue
  his or her private interests at others expense

3
Moral Hazard Slacking Employees

• Employees on wages with little effective
  monitoring.
• An office employee may spend time shirking
  (slacking), studying for an exam, or chatting on
  the phone with friends when there is work waiting
  to be done.

4
Moral Hazard Slacking Employees

• Employees on wages with little effective
  monitoring.
• All sorts of shirking are MH problems

5
Moral Hazard Senior Executives

• Senior executives may pursue their own goals of
  status, high salaries, expensive perks, and job
  security rather than the stockholders interests
• They may push sales growth over profits.
•  

6
Moral Hazard Senior Executives

• They may treat themselves to huge staffs and
  corporate jets, and
• They may oppose takeovers that would oust them
  and increase the value of the firm.
•  

7
Moral Hazard Senior Executives

• Senior executives may ignore the shareholders
  rightful claims, building executive offices that
  are not exactly spartan by nature.

8
Moral Hazard Public Executives

• Elected officials given public trust cannot
  usually be monitored much of the time.
• They may pursue their personal interests rather
  than those of the public.

9
The Principal-Agent Relationship

• The Principal is the owner of resources
• The Agent is hired by the principal and given a
  certain stewardship over the owners resources.

10
The Principal-Agent Relationship

• The arrangement will usually be based on a
  contract imperfectly describing future
  contingencies.
• Post-contractual behavior of the agent must be
  either monitored or properly motivated.

11
Moral Hazard in P-A Relationships

• Moral Hazard occurs when the agent acts in behalf
  the principal, and is supposed to advance the
  principals goals. Because the agent and
  principal have differing objectives, however, and
  because the principal cannot easily determine
  whether the agents actions are actually
  self-interested misbehavior, moral hazard
  characterizes many principle-agent situations.