The principal-agent approach to EU studies: Apply liberally but handle with care

Abstract

In An Inquiry in the Nature and Causes of the Wealth of Nations, Adam Smith warned that directors of joint-stock companies, being the managers ‘of other people’s money y are apt to consider attention to small matters as not for their master’s honour’ (Smith, 1776, Book 5: Chapter 1). Smith’s assertion reflects the long-standing interest of economists in the consequences of separating the ownership and control of firms, with pioneering contributions to the field including Berle and Means (1932) on the crisis of control in US corporations in the run-up to the Great Depression and Coase (1937) on the optimal size of firms. Building on this earlier work, proponents of the new organizational economics in the 1970s developed the principal-agent approach as a means of understanding the contractual relationship ‘between two (or more) parties when one of these, designated the agent, acts on behalf of or as representative for the other, the principal’ (Ross, 1973, pp. 134–139). Early applications of the principal-agent approach in the economics domain focused on profit-sharing incentives in government contracts (Berhold, 1971), insurance contracts (Spence and Zeckhauser, 1971) and the ownership structure of firms (Jensen and Meckling, 1976). Political scientists were quick to realize the usefulness of this new approach as demonstrated by Banfield’s influential principal-agent analysis of political corruption (Banfield, 1975). Over the last 30 years, the principal-agent approach has been applied to an array of political science topics, ranging from the oversight function of the US Congress (Weingast and Moran, 1983),