The principal-agent problem

In business and politics

It’s a standard in business ethics that there is a “principal-agent problem.”  Simply put, the problem is that those who run businesses are often not the owners but agents appointed by (or otherwise placed) to run the business for owners and those agents have their own interests in mind when operating the business, even if they also have the interests of the owners in mind.  They want to increase their salaries, perhaps increase their ownership of the business, perhaps increase their ability to get higher paying jobs with other businesses or in government, perhaps try to get on the boards of other businesses, etc.  They may simply want to put in less effort than an owner-operator would.  Of course, some of the agent’s interests may be the same as, or congruent with, the interests of the owners.  Some inevitably will not.

In the modern corporation, stockholders are the owners and CEOs are the primary agents running the business for the stockholders.  This, though, is not the only sphere in which the problem occurs.  The same—or a parallel—problem can be seen in a number of other situations.  For example, it can be seen in homeowner’s associations and in standard politics.

Officers of homeowners associations may be elected by the homeowners, but once in office, will have the ability to act on their own interests rather than only acting on those of the association and other owners.  If the association is negotiating to have plumbing work done, for example, officers might seek to bundle in to the contract work on their own property and this may make the contract more expensive for the association than it would otherwise be.  Something similar will be true of governments (at all levels).

A city manager may be responsible for negotiating a contract for their city and bundle in work for their own property.  Or they may suggest that a firm seeking the contract would have a better chance at securing it if they discussed the contract over dinner at their favorite (expensive) restaurant.  Mayors and governors as well as city and state legislators may all be in similar positions.  Obviously, the same is true of presidents and federal legislators.  (I should note that the point I am making here is perhaps the most basic lesson of public choice economics.)

The problem when applied to governments is, I think, worse than when it is applied elsewhere.  In businesses, the owner or owners consents to the agent’s work and presumably does so knowing about the problem and taking whatever precautions they think worthwhile.  The owners can also (usually) replace to agents with people they think will do better for them. Similarly, if you think your homeowner’s association is acting in unacceptable ways, you can seek to change the officers and, if that proves impossible, can move, selling your home and refusing to accept the problematic behavior of those who are meant to operate in your interests.  That is significantly more difficult, though, with governments. (It is harder to withhold consent from governments. Putting the same point a different way, it’s more difficult to assure genuine voluntary and informed consent to governments.)

Ignoring the fact that neither President Biden nor former President Trump are likely to act in ways that I would agree are in my interests, the bigger issue is that neither the Democratic nor the Republican Party seems to operate in ways congruent with (what I think of as) my interests.  In fact, it’s not clear to me that either party now operates in a way that is conducive to the interests of most of those who consider themselves affiliated to the party.  The parties consistently fail to nominate the best candidates available.

The problem is not limited to the US.  Do the leaders of Russia, China, Iran, Hungary, Israel, or Gaza act in ways that are really in the interests of their constituents?  To consider just the situation in Israel now: Netanyahu is not adored by the overwhelming population of Israelis; he seems to be a poor agent for many (admittedly, he’s just agreed to work with the opposition, improving the degree to which Israelis are represented; but by how much?).  Similarly, the leaders of Hamas seem poor leaders for the average Palestinian in Gaza, just as the leaders of the PLO were likely poor agents of the Palestinian people generally.

We might also note that this is a completely general problem with groups.  The leaders of BLM may not speak well for all African-Americans.  The leaders of Native American tribes may not speak well for all of their members.  The leaders of the Catholic Church may not speak well for all Catholics.  Self appointed leaders of cultural groups and leaders of cultural groups appointed by those in government to serve as liaisons are often part of the problem (whatever the problem may be).  They may be members of the minority cultural groups they claim to represent, but they nonetheless often have their own interests at heart more than the interests of their groups.

I’m not offering any solution to the problem in Israel or to the principal-agent problem generally.  I am simply noting the problem.  Any people—the principals—in modern society must rely on agents and there’s always going to be a worry that those agents do as they do more for their own interests than for those of their principals.  If there is a solution, perhaps it’s removing the agents.  All agents.

Some will say “look, you are right that agents can work in ways that benefit themselves more than their principals, but this just means we need to get better agents.”  Just what an agent is supposed to do—should they do what the principal tells them to do or what is best for their principal?—is itself a difficult question.  Even given an answer to that question and even with full knowledge of what the agent should do, there will be a question about how to encourage the agent to do that rather than act in their own interest.  These are huge questions.  Perhaps the best answer is to simply not have agents.  Alternatively, perhaps the best answer is to only have agents that are genuinely consented to by all principals.  That is possible in business firms and homeowners associations.  It’s unlikely to be possible in any government, so perhaps we should simply endorse anarchism.

(Thanks Pierre for a question that prompted this.)