Barnard also stresses how often material or financial incentives are ineffective to solve the principal-agent problem (which at the time were almost exclusively considered by economic theory): “even in purely commercial organizations, material incentives are so weak as to be almost negligible except when reinforced by other incentives” (1971). To solve this conundrum, other types of solutions must be put in place. For instance, in the shareholder-CEO example mentioned above, it might be optimal to gather the shareholders and executive board to discuss and realign on the objectives of the organization looking ahead.
More examples of the principal-agent problem
Throughout this article, we have focused our attention on the principal-agent problem in relation to organizations; the main focus of agency theory literature. However, there are a plethora of situations and day-to-day examples where we see this problem arising and being solved.
For example, a landlord (principal) delegates the rental of flats to a letting agency (agent). With a well-designed contract in place, the principal avoids any unintended agency costs such as the agent benefiting from exorbitantly high margins, or following unstandardized and biased criteria when choosing tenants.
The principal-agent problem can be extrapolated beyond the business world too, and can be found in such areas as politics and international affairs. For example, the relationship between voters and governments can be seen as a principal-agent problem, where voters (the principals) delegate the ruling and mandate of their nation to a government (the agent). The election manifesto and votes may be interpreted as the “contract” that both parties confidently sign to enact the desired policies.
Equally, as editors Andreas Dür and Manfred Elsig summarize, The European Union’s Foreign Economic Policies (2014) discusses how the principal-agent model behaves in the context of different international relations and affairs: