Can I Trust You? How Google and Apple Approach The Principal-Agent Problem
One of the most frustrating problems in modern finance is the issue known as the “principal-agent problem.” In fact, most of our modern financial apparatus – the web of banks, equity analysts, media reporters, and Boards of Directors, among others – exist mostly to find an answer to this intractable problem. But what it is?
Let’s imagine that you suffered an injury that prevented you from leaving your home. You’d still need to eat, so let’s say you hire someone to go to the grocery, purchase groceries, and bring them back. You pay them a wage for this service and give them money for groceries. This employee – this agent – is fulfilling a specific task for you, and you have desires associated with that task. Namely, you’d like them to buy groceries, preferably at the same quality and price point that you would have were you shopping for yourself.
But let’s take a moment to look at the incentives of that person. Once they get to the grocery store, you aren’t there, and they have complete and total control over what they do with your money. They could buy less expensive food than you might desire and cover it up from you, pocketing the excess money. They might take advantage of sales and not inform you – once again, pocketing the difference for themselves. You would not expect them to do this – after all, you’re trusting them with your grocery budget and paying them to be contentious – but you have no idea what they’re doing.
This example is a brief demonstration of the principal/agent problem. You – the principal – are paying an employee – the agent – to provide a service, but the incentives involved encourage that employee to behave in ways you might not desire. How do you solve this? How do you place more control?
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