Principal-Agent Theory

The principal-agent theory explains the relationship between an individual (individuals), called principal, who delegates the authority to an individual (individuals), called agent, to perform certain tasks or behaviors. However, the principal and the agent do not share the same information, and this often creates conflict between them during the process of fulfilling the task, which is called the principal-agent problem.

The principal-agent problem can be observed anywhere, from our daily life to complex organizations. For example, when you take your car to a mechanic, you are involved in the principal-agent problem. Another example would be a group of shareholders choosing a president to run a big corporation or a firm. In both cases, the process can be explained by the principal-agent theory in that you and the shareholders are the principal and the mechanic and the president are the agents in the framework of the theory. Clearly, the objective in the first case is to get the car repaired; however, the mechanic or the agent may engage in other activities to try to take advantage of the ignorance of the owner of the car, such as doing unnecessary work on the car so that more money can be raised for the shop. Similarly, the president of the company may behave in a way that is not compatible with the stockholders' objective of maximizing their profit. For instance, the agent or the president may take long and expensive vacations at the expense of the firm instead of focusing on maximizing the profit, called shirking activities. In either case, the problem arises because the parties, the principal and the agent, do not share the same information, which leads to unwanted actions.

This difference in the information is called asymmetric information, which is the main assumption of the principal-agent theory. The asymmetry of the information is present both before and after the principal and agent are involved in a contract. The existence of the asymmetric information before the contract is called adverse selection, which creates problems when finding the best agent to accomplish the task. On the other hand, the asymmetry of the information after the contract is called moral hazard, which can result in issues when the agent is performing the task. In that respect, the principal-agent problem is more apparent, and it can be thought of as a special case of the moral hazard problem.

The principle-agent theory is extensively used and popularized by economists in explaining the behavior of a profit-maximizing firm. However, it has been extended into other areas because of the uncertainty and asymmetry of the information shared by individuals in organizations. These areas include politics, research, health, and government organizations, and education is no exception. In education, the principal-agent relationship exists in the following situations: school boards and superintendent, superintendent and principals, and principals and teachers and other workers. The superintendent (the agent) is assumed to run the schools, but he or she may have some hidden agenda that the school board (the principal) is not aware of. Likewise, the superintendent (in this case the principal) hires school principals (the agents) to run specific schools, but the school principals can engage in some other activities that are not desired by the superintendent. Finally, teachers and other school workers may have been involved in actions that are in conflict with the objective of teaching students.

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