The principal–agent problem , in political science and economics, (also known as

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The principal–agent problem, in political science and economics, (also known as agency dilemma or the agency problem) occurs when one person or entity (the "agent") is able to make decisions on behalf of, or that impact, another person or entity: the "principal".This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard.

Common examples of this relationship include corporate management (agent) and shareholders (principal), politicians (agent) and voters (principal), or brokers (agent) and markets (buyers and sellers, principals).Consider a legal client (the principal) wondering whether their lawyer (the agent) is recommending protracted legal proceedings because it is truly necessary for the client's well being, or because it will generate income for the lawyer. In fact the problem can arise in almost any context where one party is being paid by another to do something where the agent has a small or nonexistent share in the outcome, whether in formal employment or a negotiated deal such as paying for household jobs or car repairs.

The problem arises where the two parties have different interests and asymmetric information (the agent having more information), such that the principal cannot directly ensure that the agent is always acting in their (the principal's) best interest,particularly when activities that are useful to the principal are costly to the agent, and where elements of what the agent does are costly for the principal to observe (see moral hazard and conflict of interest). Often, the principal may be sufficiently concerned at the possibility of being exploited by the agent that they choose not to enter into the transaction at all, when it would have been mutually beneficial: a suboptimal outcome that can lower welfare overall. The deviation from the principal's interest by the agent is called "agency costs".

The principal-agent problem describes challenges that occur when agents and principals have conflicting interests. Democratically elected forms of government are common in many First World countries. These nations are often governed as republics or direct democracies that operate by allowing citizens to choose their own government officials. These officials are agents of the people they represent.

The people, all principals by definition after electing their representatives, assume the officials are making decisions that benefit the best interests of the nation. Perfect agents, having perfect information about these best interests and being motivated to serve the principal, act to benefit the principal even when the principal's interests are in conflict with their own. Members of the public often assume their representatives in government will represent their ideal interests with few problems. Whenever government officials act in their own private interests, they potentially introduce conflict in their relationship with voters.

This challenge occurs with individual voter representation and also with businesses interacting with government representatives. One problem for industry, for example, is the potential conflict between business and hired agents helping to navigate industry regulation. Many firms have departments tasked with interpreting and applying government policy. Many of the staff hired for these departments have public sector experience and may return to government work in the future.

For these staff, there is little incentive to keep regulations simple and minimal while in public service. The best interests of the businesses conflict directly with the interests of their own government relations departments. In this sense, some people believe that corporate government relations departments act against corporate profitability by pursuing objectives that provide little benefit to competitiveness and company performance. Any challenges then would be a result of these staff members having an incentive to act against the company.

In a similar vein, representatives chosen to work in governmental organizations may have a vested interest in acting contrary to voter interests.

To mitigate principal-agent dilemmas by government, the primary method is to increase transparency. People act much more honestly and responsibly when they know that they are accountable. Of course, too much transparency can limit their freedom and spoil their mood. Agents should be chosen who have a long history of making good decisions in the interest of the people they are representing.

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5. What do.principal agent dilemmas teach us about government behav ior and the relationship of rincipal agent dilemmas?

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