Principaal-agentrelaties

A principal-agent relationship exists when one person’s welfare depends on the actions of another. An agent is hired to take actions that are in the best interests of the principal. The principal determines the goals and objectives of the agent and is impacted by the quality of the agent’s actions. 

In a corporate setting, managers are agents who take actions like planning projects and developing new products. Shareholders are principals who want to maximize their wealth.

However, managers may act in their interests. 

Imagine a company manufacturing gym equipment, including exercise bikes, treadmills, rowing machines, and resistance bands. 

One of the managers has expertise in software development and is passionate about technology.

She suggests the company should also develop smart wearable devices such as fitness bands and smart glasses.

She believes this will give her recognition in the tech community, such as more social media followers and potential awards.

The company, however, lacks the expertise and facilities to enter the tech industry.

It follows that the goals of shareholders and managers may be different, which illustrates the problem of principal-agent relationships.