The Principle/Agent Problem and Moral Hazard Prof. Phillip J. Bryson Marriott School of Management

Moral hazard is the form of –postcontractual opportunism –that arises because actions that have efficiency consequences are not freely observable (monitoring problem) –so the person taking them may choose to pursue his or her private interests at others’ expense Moral Hazard

Moral Hazard: Slacking Employees Employees on wages with little effective monitoring. An office employee may spend time shirking (slacking), studying for an exam, or chatting on the phone with friends when there is work waiting to be done.

Moral Hazard: Slacking Employees Employees on wages with little effective monitoring. All sorts of shirking are MH problems

Moral Hazard: Senior Executives Senior executives may pursue their own goals of status, high salaries, expensive perks, and job security rather than the stockholders’ interests They may push sales growth over profits.

Moral Hazard: Senior Executives They may treat themselves to huge staffs and corporate jets, and They may oppose takeovers that would oust them and increase the value of the firm.

Moral Hazard: Senior Executives Senior executives may ignore the shareholder’s rightful claims, building executive offices that are not exactly spartan by nature.

Moral Hazard: Public Executives Elected officials given public trust cannot usually be monitored much of the time. They may pursue their personal interests rather than those of the public.

The Principal-Agent Relationship The Principal is the owner of resources The Agent is hired by the principal and given a certain stewardship over the owner’s resources.

The Principal-Agent Relationship The arrangement will usually be based on a contract imperfectly describing future contingencies. Post-contractual behavior of the agent must be either monitored or properly motivated.

Moral Hazard in P-A Relationships Moral Hazard occurs when the agent acts in behalf the principal, and is supposed to advance the principal’s goals. Because the agent and principal have differing objectives, however, and because the principal cannot easily determine whether the agent’s actions are actually self-interested misbehavior, moral hazard characterizes many principle- agent situations.