You are the owner of a clothing retail store in Manhattan that sells brand name

Question

You are the owner of a clothing retail store in Manhattan that sells brand name clothes, including high-end clothing brands. Your retail salespersons are paid a mean hourly wage of $12. Over the last several months, your sales have significantly declined and customer satisfaction surveys indicate that your customers are increasingly dissatisfied with the quality of service. You just took a course in microeconomics for business decisions in which you learned about the concept of principal-agent problem. To what extent should you apply this concept to increase the motivation of your retail salespersons? How should the performance of the retail salespersons be evaluated? Should you redesign the structure of compensation in terms of fixed pay (hourly wage) and variable pay (bonus, commissions…)?

Explanation / Answer

The market outcomes can be very different with asymmetric information. The asymmetric information problem occurs when there is lack of information about the economic agents and the goods in the market.

The asymmetric information creates inefficient market outcomes by creating many problems. The problem that arises in an economic transaction that involves asymmetric information is called principle agent problem. In principle–agent problem the principle hires an agent to perform certain task but fails to monitor the self-interest driven action of the agent and this alters the profit of the principle.

If a labor is hired to perform a job and it is not possible to monitor her work, it is best to tie the reward of the labor to firm’s performance. This will reduce the principle-agent problem and will increase the net benefit of the producer.

The performence of the retail salesperson should be measured by the number of unit he/she sales. This will make the firm judge and distinguish between most productive agent to unproductive agents.

The store must redisgn the payment structure such a way that the agent will get the fraction of sales or bonus and incentive based upon the unit sales. This way each employee will be productive and this will increase the sales of the firm too.

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