Sub: Economics Topic: Micro Economics
Question:
The principle agent relationship
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Give an example of a principal agent relationship in a business and briefly explain how different
goals and incentives for the principal and agent can lead of problems for that business.
Solution:
Example: A typical example of agent is the salesperson in a department store. The salesperson
is an agent (and a department store employee) and he/she represents a department store - the
principal.
The different goals and incentive for the principal and agent would lead to problem for that
business as follows,
The agency describes an agreement between two people where one will be a representative of
another - the principal and the agent. In other words, the principal is a person who wants to
achieve something and he/she hires an agent to help him/her to achieve it. The principal-agent
relationship means, that both parties agree, that agent will represent the principal in doing
business.
The employee is an agent with respect to business transaction and a servant or independent
contractor with respect to perform physical tasks. One of the most important duty an agent
owes to principal is loyalty. Principal hires an agent to serve the principal's interest, not the
agent's own interest. Agent should perform the duty to avoid the conflict of interests. For
example, principal A hires agent B to buy goods. Agent B should not buy good for principal A
from himself.
In principal-agent relationship, each party owes the other a duty act in good faith. The principal
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Sub: Economics Topic: Micro Economics
owes agent compensation, reimbursement for the expenses, and comply with the terms of the
agreement. The agent owes principal the loyalty, must obey the instructions, and reasonably
care for the business and the principal's money.
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*The Homework solutions from ClassOf1 are intended to help the student understand the approach to solving the problem and not for submitting the same in
lieu of your academic submissions for grades.