I’ve been pondering the Principal-Agent problem and Moral Hazard recently and it strikes me that it’s a ubiquitous and fundamental feature of large organizations:  business, political, social.

The Principal-Agent problem can occur when one person, the Principal, delegates authority to another, the Agent, to act on their behalf.  There are lots of cases in which the interests of the two parties don’t align and the Agent acts in their own interest, rather than the interest of the Principal they’re supposed to be representing.

A real estate agent prioritizes selling your house quickly rather than for the best price.  They make more money on transaction volume than price.  A contractor low bids to win work, knowing that the client will end up paying them the excess.  A department head hoards headcount or capital funding instead of following the stated resource allocation priorities of the organization.

This isn’t something we covered extensively and explicitly in B-School, although I feel it should have been.  It’s not only a common-sense observation about the world and organizations in the world, but it’s a critical element of business, political, and social dynamics and operations.

We have some standard tools—contracts, incentive structures—intended to mitigate the problem.  They’re certainly better than nothing.  They’re also certainly not dispositive of the problem.

Try reading the headlines with this in mind…see if it’s a useful lens.  It seems to me to explain a broad swath of organizations that ‘aren’t working.’

-Chris

Find a reasonably comprehensive discussion here: https://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem