Principal Agent Theory
The Principal Agent-Theory as a base for the organization of company innovation process
There are many settings in which one economic actor (the principal) delegates authority and/or responsibilities to an agent to act on his behalf. The primary reason for doing so is that the agent has an advantage in terms of expertise or information. This informational advantage, or information asymmetry, poses a problem for the principal—how can the principal be sure that the agent has in fact acted in her best interests? Can a contract be written defining incentives in such a way that the principal can be assured that the agent is taking just the action that she would take, had she the information available to the agent?
Solving this problem is a matter of some concern for patients dealing with their doctors, clients dealing with their lawyers, etc. It is also a crucial concern for business firms dealing with their employees. Especially in the twenty-first century, employees are often hired precisely because they have information available that is unavailable to the managers of a firm, who changes or implements new ways of work (Innovation), making sure that employee expertise is put to work in the interest of the firm can make the difference between success and bankruptcy–as illustrated by the performance of Google Corporation and their success.
Principal-Agent Theory
The key common aspect of all those contracting settings is that the information gap between the principal and the agent has some fundamental implications for the design of the bilateral contract they sign.
In order to reach an efficient use of economic resources, this contract must elicit the agent´s private information. This can only be done by giving up some information rent to the privately informed agent. Generally, this rent is costly to the principal. This cost or payment is what is known as Monitoring Cost, on which the Principal can limit divergences from his interest by establishing
There are many settings in which one economic actor (the principal) delegates authority and/or responsibilities to an agent to act on his behalf. The primary reason for doing so is that the agent has an advantage in terms of expertise or information. This informational advantage, or information asymmetry, poses a problem for the principal—how can the principal be sure that the agent has in fact acted in her best interests? Can a contract be written defining incentives in such a way that the principal can be assured that the agent is taking just the action that she would take, had she the information available to the agent?
Solving this problem is a matter of some concern for patients dealing with their doctors, clients dealing with their lawyers, etc. It is also a crucial concern for business firms dealing with their employees. Especially in the twenty-first century, employees are often hired precisely because they have information available that is unavailable to the managers of a firm, who changes or implements new ways of work (Innovation), making sure that employee expertise is put to work in the interest of the firm can make the difference between success and bankruptcy–as illustrated by the performance of Google Corporation and their success.
Principal-Agent Theory
The key common aspect of all those contracting settings is that the information gap between the principal and the agent has some fundamental implications for the design of the bilateral contract they sign.
In order to reach an efficient use of economic resources, this contract must elicit the agent´s private information. This can only be done by giving up some information rent to the privately informed agent. Generally, this rent is costly to the principal. This cost or payment is what is known as Monitoring Cost, on which the Principal can limit divergences from his interest by establishing
Bibliography: Merton H. Miller; Kevin Rock;1985; Dividend Policy under Asymmetric Information; The Journal of Finance, Vol. 40, No. 4. (Sep., 1985), pp. 1031-1051. Andrew H. Van de Ven; 1986; Central Problems in the Management of Innovation; Management Science, Vol. 32, No. 5, Organization Design (May, 1986), pp. 590-607. Bengt Holmstrom; 1979; Moral Hazard and Observability; The Bell Journal of Economics, Vol. 10, No. 1, (Spring, 1979), pp. 74-91. Janis I., Groupthink; 1982; "Sources of Error in Strategic Decision Making," in J. Pennings (ed.), Strategic Decision Making in Complex Organizations, Jossey-Bass, San Francisco, 1985.