Principal-Agent Model

The principal-agent model deals with relationships in the public service in terms of various kinds of agreements or contracts between principal (the government or employer) and agent (employee or contractor). The central dilemma investigated by principal-agent theorists is how to get the agent to act in the best interests of the principal when the government or contractor [Page 746]has an informational advantage over the principal and has different interests from the principal.

Principal-agent theory rests on a basis in economics. Principal-agent theory in economics makes these information asymmetries central to the emergence of institutional structures that organize the workplace and management-staff (principal-agent) relations. The more difficult it is for the principal to gain information on performance outcomes, the more likely that contracts will be framed instead in terms of contractor behavior. The more uncertain the outcomes, the more the agent will have an incentive to resist the principal's informationgathering efforts so as to encourage behavioral rather than outcome performance standards.

The principal-agent approach is especially insightful for handling disequilibrium situations and taking into account the role of the information at the microlevel. The principal-agent theory wrestles with the problem of ensuring that agents serve principals in accordance with stated or implied contractual conditions. The essential policy prescription is to clarify and define the relationships between agency heads and top bureaucrats, and between the latter and departmental managers at lower levels.

Principal-agent theory also played an important role in developing the policy framework that underpinned the corporatization and privatization programs in several countries. The dominant state ownership was (still is in some countries) a typical feature of most state-owned economies. This permits us to consider the transition as a change of ownership structure—a radical privatization will transform the whole. From a theoretical perspective, the implications of the change of the ownership structure can be analyzed in the boundaries of the principal-agent model. The model can be used as a theoretical basis for transition economic policy. This theory has been successfully applied to the problems of the interdependence between the competitive market structures, ownership, and economic efficiency. It is also a useful tool for the study of the role of the financial markets and the different techniques of privatization.

Some rational choice scholars argue that politics can be best understood as a chain of principal-agent relationships: The citizenry empowers the elected officials, the legislature in turn delegates its collective power to its various standing committees, which in turn delegate authority to various government agencies (e.g., department of education, health and human services agency), which are organized internally as bureaucratic hierarchies. From the principal-agent theoretical perspective, the key issue is democratic control. Good government performance will be obtained when each agent receives the proper incentives from its political superiors.