Principal-agent Problem Research Articles

Optimal agency contract for incentive and control under moral hazard in dynamic electric power networks

The authors propose an optimal contract mechanism under moral hazard in discrete-time dynamic electric power networks. As the utility (system operator) cannot adjust the control input of the agents (end-users) directly in real time out of respect for individual decision–making, the agents’ control input maximising their own profit does not always maximise social welfare. To avoid the issue, the authors introduce an aggregator as intermediary between the utility and the agents. The aggregator pays compensation for defective ancillary services, which are caused by random disturbance and the agents’ voluntary control. To reduce the compensation risk, the authors first present an optimal incentive/control contract problem for the aggregator's compensation. The problem is usually regarded as a principal-agent problem under moral hazard in contract theory. However, it is generally difficult to solve a contract problem with dynamics expressed as discrete-time simultaneous Bellman equations and a hierarchical control structure as a Stackelberg game. The authors next show that the problem can be solved by regarding it as a linear-exponential-quadratic-Gaussian dynamic game and employing a numerical optimisation technique. Due to the ex-ante appropriate payment contract, the agents select control inputs preferable for the aggregator. The effectiveness of the proposed contract mechanism is finally demonstrated through simulation.

Large Shareholders’ Power and the Quality of Corporate Governance: An Analysis of Brazilian Firms

This paper analyzes the incentives of large shareholders to implement the corporate governance system that favors their interests within a framework of highly concentrated ownership and poor legal protection for investors. A metric for corporate governance based on the fulfillment of non-mandatory rules of good corporate governance is used. System GMM (Generalized Method of Moments) estimates for a balanced panel data of Brazilian firms reveal that the ownership concentration is detrimental to corporate governance quality and the quality of board composition. In accordance with the expropriation effect on principal-principal agency conflicts, by weakening the corporate governance system and board composition, large controlling shareholders may use private benefits of control. As proposed by the substitution effect, in a complementary way, controlling shareholders may renounce strong boards and directly perform management monitoring, mitigating agency conflicts with managers. Finally, the ability of large shareholders other than the main blockholder is not enough to contest his/her power to shape the corporate governance system. The work provides evidence of the prominence of the principal–principal agency problem in an emerging market, by analyzing the effect of ownership concentration over the quality of the corporate governance system, and also that other large non-controlling shareholders are not able to contest the power of the main blockholder.

Learning Hidden Action Principal-Agent Models

The design of performance-based incentives -- commonly used in online labor platforms -- is naturally posed as a moral-hazard principal-agent problem. A key input in this setting is the dependence of agent output on effort, which is unlikely to be known in practice. In this paper, we consider the estimation of a principal-agent model, with a focus on the parameters that link agent output and effort. We first present an estimator for a non-parametric agent model and show it to be statistically consistent. To circumvent computational challenges with solving the estimation problem exactly, we approximate it as an integer program, which we solve through a column generation algorithm that uses hypothesis tests to select variables. We show that our approximation scheme and solution technique both preserve the estimator's consistency and combine to dramatically reduce the computational time required to obtain competitive parameter estimates. To demonstrate our approach, we conducted a randomized experiment on a crowdwork platform (Amazon Mechanical Turk), where incentive contracts were randomly assigned among a pool of workers completing the same task. We present numerical results illustrating how the proposed estimator combined with experimentation can shed light on the efficacy of performance-based incentives.

Policy forum: Domestic Tax Arbitration: Some Economic Considerations

In this article, we discuss the economic arguments for and against domestic tax arbitration. Beyond the standard benefits and costs widely discussed by the literature on private arbitration, we emphasize two additional concerns: agency costs (because there is a significant principal-agent problem within the government) and fast lane effect (less public investment in improving tax courts). We conclude that the skepticism echoed by legal economists contrasts with the more optimistic view shared by other legal scholars and policymakers.

Large shareholders’ power and the quality of corporate governance: An analysis of Brazilian firms

This paper analyzes the incentives of large shareholders to implement the corporate governance system that favors their interests within a framework of highly concentrated ownership and poor legal protection for investors. A metric for corporate governance based on the fulfillment of non-mandatory rules of good corporate governance is used. System GMM (Generalized Method of Moments) estimates for a balanced panel data of Brazilian firms reveal that the ownership concentration is detrimental to corporate governance quality and the quality of board composition. In accordance with the expropriation effect on principal-principal agency conflicts, by weakening the corporate governance system and board composition, large controlling shareholders may use private benefits of control. As proposed by the substitution effect, in a complementary way, controlling shareholders may renounce strong boards and directly perform management monitoring, mitigating agency conflicts with managers. Finally, the ability of large shareholders other than the main blockholder is not enough to contest his/her power to shape the corporate governance system. The work provides evidence of the prominence of the principal–principal agency problem in an emerging market, by analyzing the effect of ownership concentration over the quality of the corporate governance system, and also that other large non-controlling shareholders are not able to contest the power of the main blockholder.

A Bayesian approach to continuous type principal-agent problems

Singham (2019) proposed an important advance in the numerical solution of continuous type principal-agent problems using Monte Carlo simulations from the distribution of agent “types” followed by bootstrapping. In this paper, we propose a Bayesian approach to the problem which produces nearly the same results without the need to rely on optimization or lower and upper bounds for the optimal value of the objective function. Specifically, we cast the problem in terms of maximizing the posterior expectation with respect to a suitable posterior measure. In turn, we use efficient Markov Chain Monte Carlo techniques to perform the computations.

Executive Compensation: Its Structure, Links to Company Performance, Executives' Perception, and International Differences

Despite the vast amount of academic research on particular aspects of executive compensation, few studies have undertaken the subject comprehensively, combining the perspective of a firm and a manager in the International context. This study is a review of contemporary executive compensation schemes including its structure and links to company performance. Based on the literaturę of the topie, the latest market studies and industry expert interviews, this paper determines the role and effectiveness of particular components of compensation packages, taking into consideration executives’ perception, motivation, and the existing behavioral biases. Additionally, the study analyses the major differences in executive compensation policies of the listed companies in the US, the UK, Australia, Poland, and Norway. The research conclusions prove that executive compensation maximizing benefits for a firm should not only address the principal-agent problem through properly designed incentives, but also reduce a manager s propensity to excessive risk-taking. Finally, it provides practical recommendations for compensation committees how to effectively design remuneration policies.

Ensuring environmental performance in green leases: the role of facilities managers

PurposeA green lease incorporates sustainability practices to reduce a building’s negative impact on the environment. Facilities managers play an important role in ensuring these best practices are implemented during the operational stage of a building; however, green leasing is an under-researched area in the emerging field of sustainable facilities management (SFM). This paper aims to investigate the common barriers encountered in ensuring environmental performance when a green lease agreement is in operation between a landlord and tenant.Design/methodology/approachThis research was conducted in three stages using the principal-agent problem as the theoretical foundation for data collection. Stages 1 and 2 used semi-structured interviews to collect data with policy/corporate-level professionals, landlord and facilities management representatives who have considerable experience in green leases. Stage 3 used document reviews based on summative content analysis to further evaluate the extent of the contextual use of green leasing concepts as used within the facilities management community.FindingsThe study confirmed a strong incentive gap and information asymmetry between the landlord and facilities manager, forming a typical double principal-agent problem when the split incentives between the landlord and tenants are also taken into consideration, which results in agents acting on their own self-interest rather than the interests of the principal. Goal alignment is found to be key for the successful operation and management of a building throughout its life; when present, these goal conflicts can lead to disharmony between the parties to the contract.Research limitations/implicationsThe study proposes a few practical measures to close the gaps in incentive and information asymmetry that create the principal-agent problem, while providing recommendations to the facilities management professional community. These recommendations could be included in future revisions of the SFM guidelines or code of practices used by the industry. Although this study exposed a rather neglected area of the facilities manager’s role in green leases, the findings are limited by the relatively small sample size used for the interviews.Originality/valueThis study contributes to the SFM body of knowledge from a green lease perspective, and the theoretical framework in the double principal-agent problem introduced in the study could be used in future research endeavours.

Value-Drivers and Some Principal-Agent Conflicts in Commercial Real Estate Portfolios: A Company-Level and Market-Level Analysis

This article: i) explains some drivers of both business value and real estate value of commercial retail real estate portfolios; ii) illustrates some principal-agent problems that arise from investment and control of operating companies by hedge funds and private equity funds.

DEA models for two decision makers with conflicts: the principal-agent problem

This paper studies the impact of two decision makers’ interaction with conflicts on the efficiencies of the system. We start with a general principal-agent framework where the principal and the agent make decisions independently and the principal has a contradictive objective to that of the agent. We develop data envelopment analysis (DEA) models in the principal’s and the agent’s perspectives respectively. Non-cooperation between the principal and the agent is discussed to illustrate how one decision maker affects the other and the corresponding efficiency and incentive contract of the system. In addition, cooperation of the two parties is also analyzed to better derive how the performance of the system is influenced by the parties and their interactions as well. Then, this study illustrates the proposed models and effective incentive contracts by applying them to the efficiency evaluations of 22 China listed electric power companies.

Changes in Firms’ Political Investment Opportunities, Managerial Accountability, and Reputational Risk

We use the U.S. Supreme Court’s decision in Citizens United v. Federal Election Commission to assess the reputational risks created by political investment opportunities that allow managers to spend unlimited and potentially undisclosed firm resources on independent political expenditures. This new opportunity raises important ethical questions, as it is difficult, and perhaps impossible, under current law for shareholders to hold managers accountable for this investment choice and the reputational risks it entails. Using firms’ known political activity as a proxy for managers’ likely future use of independent political expenditures, we examine how market participants reacted to Citizens United, conditional on this prior activity and corporate governance attributes related to the concentration of decision rights in senior management and blockholders. The results of our analyses document that firms with both a high level of known political activity and CEO-chairperson of the board duality experienced negative abnormal returns in reaction to Citizens United. In contrast, firms with concentrated ownership experienced positive abnormal returns; however, as known political activity increased, investors discounted the benefits of concentrated ownership. These findings suggest that investors expect this expansion of firms’ political investment opportunities to amplify principal-agent problems inherent in corporate political activity. Additionally, our findings provide evidence for those deliberating the mandatory disclosure of firms’ investments in politics as a means of increasing managerial accountability to both shareholders and the public.

Negotiating Intergovernmental Relations Under ESSA

The Every Student Succeeds Act (ESSA) has generated considerable buzz in education circles and the general media. But how much has really changed, and what does this mean for states as they begin the process of implementing a new federal education law? In this article, we apply principal-agent theory to explore intergovernmental relations under ESSA, focusing specifically on the relationship between the federal government (the principal) and state governments (the agents). First, we review power dynamics under No Child Left Behind (NCLB) and ESSA, exploring implications of changes in the substance of both laws for the principal-agent problem. Next, using political discourse analysis, we show how shifts in the content of Elementary and Secondary Education Act (ESEA) and its implementation by the current administration influenced the federal review process of state plans for the sixteen states that submitted plans under the early deadline. We find the federal government was most likely to provide feedback around Title I, Part A, Section 4 pertaining to accountability and school improvement. Ultimately, however, states that ignored or defied federal feedback were successful given both the limits ESSA places on U.S. Department of Education authority and the current administration’s reliance on negotiation over sanction. Thus far, this approach has ensured states are realizing the maximum flexibility available through the law, as all state plans were approved, regardless of whether states heeded federal feedback and complied with the law.

Optimal Electricity Demand Response Contracting With Responsiveness Incentives

Despite the success of demand response programs in retail electricity markets in reducing average consumption, the random responsiveness of consumers to price event makes their efficiency questionable to achieve the flexibility needed for electric systems with a large share of renewable energy. The variance of consumers' responses depreciates the value of these mechanisms and makes them weakly reliable. This paper aims at designing demand response contracts which allow to act on both the average consumption and its variance. The interaction between a risk--averse producer and a risk--averse consumer is modelled as a Principal-Agent problem, thus accounting for the moral hazard underlying demand response contracts. The producer, facing the limited flexibility of production, pays an appropriate incentive compensation to encourage the consumer to reduce his average consumption and to enhance his responsiveness. We provide closed--form solution for the optimal contract in the case of constant marginal costs of energy and volatility for the producer and constant marginal value of energy for the consumer. We show that the optimal contract has a rebate form where the initial condition of the consumption serves as a baseline. Further, the consumer cannot manipulate the baseline at his own advantage. The first--best price for energy is a convex combination of the marginal cost and the marginal value of energy where the weights are given by the risk--aversion ratios, and the first--best price for volatility is the risk--aversion ratio times the marginal cost of volatility. The second--best price for energy and volatility are non--constant and non--increasing in time. The price for energy is lower (resp. higher) than the marginal cost of energy during peak--load (resp. off--peak) periods. We illustrate the potential benefit issued from the implementation of an incentive mechanism on the responsiveness of the consumer by calibrating our model with publicly available data. We predict a significant increase of responsiveness under our optimal contract and a significant increase of the producer satisfaction.

The micro-politics of implementing and resisting principal-agent relations in a weak state

ABSTRACTTo understand why quality of government (QoG) varies, scholars have drawn on two theoretical approaches: principal-agent and collective action theories. The literature tends to bifurcate these two theories, and focuses on the national scale and the structural conditions under which collective action and principal-agent problems arise. This article highlights how principal-agent relationships and collective action problems shape the implementation of decentralisation policy in two subnational governments in Papua New Guinea. It is argued that pathways to QoG are contextual, and determined by both principal-agent and collective action relationships. In the case of PNG, these relations are shaped by history, culture and the agency of elites and citizens.

Agency models based on different measures with comparison

Optimal contract regulates the expected activities of both principals and agents, and influences how the gains from the cooperation are shared between the two participators. Thus, it is necessary and wise for principals to seek for the optimal contracts during the period of negotiations. To determine the optimal contracts, there are several kinds of agency models based on different measures, such as probability measure, capacity measure, credibility measure and uncertainty measure. This paper primarily presents a comparative review of random agency model, fuzzy agency model and uncertain agency model. This comparative review is aimed at not only summarizing the structure and feature of each agency model but also guiding on how to identify the most suitable agency model for each specific principal agent problem. Motivated by this idea, these three classes of agency models are respectively investigated about their structure, feature and application, and then an empirical comparison among these models is basically carried out from several aspects, such as information diversity, decision rule and calculation. As a significant contribution, the comparative result in this paper provides the guidance for the principals on how to identify the most suitable agency model for each special principal agent problem in a certain setting.

Vertical coordination in the Brazilian milk supply chain: the case of 3B Agro LTDA

The dairy business is characterized by generally low profit margins due to a very competitive market environment. Dairy farmers and milk processing companies, therefore, constantly seek to optimize their technical production processes in pursuit of further cost reductions, e.g. by means of improving herd management, milking and feeding practices. In addition, innovative business strategies may create competitive advantage in response to market conditions. While vertical coordination or even integration have been established successfully in most sectors of animal husbandry including poultry, pork and beef production, this strategy is mostly limited to supplying contracts and input support within the dairy sector. Various organizational models of increasing vertical coordination in dairy production exist, with great variation in terms of operational performance and profitability. Using the example of 3B Agro LTDA’s dairy production located in the municipality of Toledo, Brazil, the case study illustrates the significant efficiency potential that currently exists in the Brazilian dairy supply chain. The prevalence of short-term contractual commitments and an influential role of independent intermediaries give room to considerable opportunism of market participants, various principal-agent problems and severe issues regarding milk quality. The case study illustrates that, vertical coordination can increase control and efficiency along the supply chain. It also points out the importance of strong managerial competencies and capabilities of dairy farm managers in order to exploit fully the efficiency potential provided by vertical coordination.

A Study of the Influence of Earnings Management and Accounting Information Quality on the Investment Efficiency of Chinese Listed Companies

The inefficient investment is mainly caused by information asymmetry and principal-agent problems. Earnings management is an important factor affecting the inefficient investment of enterprises. It directly affects the effectiveness of earnings information and the decision-making of investors. Accounting information, especially information disclosure, is the basis of maintaining the normal operation of investment. It can provide effective incremental information to stakeholders, and make optimal investment decisions. It is found that earnings management is positively related to investment efficiency. It shows that earnings management will have an impact on investment decision-making. Accounting information, especially information disclosure, is the basis for maintaining the normal operation of investment. It can provide effective incremental information to stakeholders and make optimal investment decisions.

Fair share and social efficiency: A mechanism in which peers decide on the payoff division

We propose and experimentally test a mechanism for a class of principal-agent problems in which agents can observe each others' efforts. In this mechanism each player costlessly assigns a share of the pie to each of the other players, after observing their contributions, and the final distribution is determined by these assignments. We show that efficiency can be achieved under this simple mechanism and, in a controlled laboratory experiment, we find that players reward others based on relative contributions in most cases and that the players' contributions improve substantially and almost immediately with 80 percent of players contributing fully.

PRINCIPLES OF INTERACTION IN INTER-ORGANIZATIONAL NETWORKS IN THE CONTEXT OF THE PRINCIPAL – AGENT ISSUE

In the development process of the economic theory, the focus is shifted from the market, being the only form of coordination of economic activity, to the personal behavior and its impact on economic processes. This reveals the importance of human habits and how they shape the socio-economic behavior. Social relations and interaction become more and more important and are seen as a factor influencing not only the daily decisions, but also the economic behavior of the personality. "Economics is seen by them as an open evolutionary system, experiencing a constant impact by the external environment through culture, political environment, nature, etc."In the development process of the economic theory, the focus is shifted from the market, being the only form of coordination of economic activity, to the personal behavior and its impact on economic processes. This reveals the importance of human habits and how they shape the socio-economic behavior. Social relations and interaction become more and more important and are seen as a factor influencing not only the daily decisions, but also the economic behavior of the personality. "Economics is seen by them as an open evolutionary system, experiencing a constant impact by the external environment through culture, political environment, nature, etc."Neoclassical theory assumes that fully rational, decision-making individuals, through their absolute awareness and using the exchange of goods on the market, strive for equilibrium and actually achieve it. New institutional economy rejects one of the most important postulates of neoclassical theory - the economy's quest for equilibrium, accepting it only as short-term (if at all possible) and uncharacteristic state. The public interest seeks to build more efficient structures/institutions, and by better defining property rights and maximizing the usefulness of each individual, to achieve greater public welfare. The most important concepts of the new institutional economy are the theory of transaction costs, the theory of property rights and the principal-agent problem theory.The problematic area of the present study is the conflicts, arising from the interaction and cooperation between different business partners, united in inter-organizational networks. The subject of this research is the theory and practice of these inter-organizational networks, reflected through the prism of "principal-agent".The expansion of the markets by counterparties and traded goods, as well as by geographic scope, leads to a de-personalization of the exchange, thus an increase in the uncertainty for the participants and consequently the cost of limiting it. The possibility of long-term reiteration of deals with the same contractor is negligible, while at the same time partners become increasingly distanced, virtual and abstract. This stimulates market participants to look for mechanisms to curb the negative effects of expanding markets - commercial contracts, bank guarantees, warranties, betting and trade codes. Their introduction is aimed at reducing the cost of obtaining information about the counterparty, the traded commodities, as well as providing guarantees to prevent opportunistic behavior after the conclusion of the agreement.

Group identity and partnership

We design a laboratory experiment to investigate how group identity influences decisions in a principal-agent framework with hidden actions and a revenue-sharing payment scheme. Group identity is induced by randomly assigning participants to groups and is further enhanced using a collective puzzle-solving task. We find that the principal makes a more generous revenue-sharing offer to the ingroup agent than to the outgroup agent. While an ingroup agent is less tolerant of a low offer from the principal, she exerts a greater effort in response to a more generous offer than does an outgroup agent. Our findings shed important light on the interplay of monetary incentives and group identity in tackling the principal-agent problem.