13.2: Principal-Agent Problems

Weber identified his ideal characteristics of bureaucracies based on their close relationship to bureaucratic efficiency: to the extent that a bureaucracy embodies these characteristics, it will achieve its goals in a more efficient manner. Yet even bureaucracies which meet most or all of these requirements are often still inefficient. Because of this, bureaucracies tend to have a negative reputation for being slow and bungling, hampered by “red tape” that prevents them from solving problems quickly and sensibly.

Although their commitment to rules and protocols can be irksome, many of the problems associated with bureaucracies have less to do with the rules and more to do with the people following (or not following) those rules. A fundamental reason why bureaucracies often fail to achieve their goals is that they are rife with principal-agent problems. A principal-agent problem occurs when someone (a principal ) asks someone else (an agent) to do something but the agent’s motivations differ from the principal’s. This difference can cause the agent to perform the assigned task in a way other than how the principal would prefer it to be done.

Any situation in which someone acts on behalf of someone else has the potential to become a principal-agent problem. When you take your car to a mechanic, order food at a restaurant, or ask your friend to dogsit for you while you are out of town, you become a principal by entrusting a task to an agent. You want the mechanic to work quickly and cheaply, the cook to wash his hands and give you generous portions, and your friend to be attentive to and careful with your dog — but the mechanic may prefer to work at a leisurely pace and overcharge you, the cook to save time by not washing his hands and money by not filling your plate, and your friend to just provide the bare minimum in pet upkeep because of how busy or lazy she is. In each case, the agent is unlikely to perform the task exactly the way you (the principal) would like it to be performed, simply because of how your motivations differ.

Not every principal-agent relationship becomes a principal-agent problem. If a principal and agent do not differ substantially in their motivations regarding a certain task, the principal may be able to trust the agent to act as the principal himself or herself would have acted.

Though principal-agent problems are common, principals continue to delegate tasks to agents despite being aware of motivational differences and the issues that may arise from them. They do this out of necessity: for all of the negative outcomes that can arise from principal-agent relationships, it is still often more efficient for principals to delegate tasks to agents than to do them themselves.

Fortunately, principals are not helpless when confronted with agents who do not share their motives. First, they can monitor agents’ performance and evaluate it for quality. This can take the form of student evaluations of professors, CCTV cameras watching a store’s cash register to make sure the cashier is not stealing from the till, or a mother inspecting her child’s room for cleanliness. Second, they can reward or punish agents on the basis of their performance. This can be accomplished through a special parking place reserved for the “Employee of the Month,” a generous tip for a timely pizza delivery driver, or the impeachment of a president for committing high crimes and misdemeanors.

Crucially, neither monitoring nor reward or punishment is by itself sufficient to solve a principal-agent problem. If agents do not expect to be rewarded or punished for good or bad performance, it will not matter how closely they are being monitored by their principals. Likewise, promises of performance-based rewards or punishments will be ineffective if no one is keeping an eye on the agents to determine whether they deserve to be rewarded or punished.