Principal agent problem

Principal agent problem

In the context of economics, principal-agent problem has the implication of the difficulties that surrounds existing conditions associated with information that is incomplete in addition to being asymmetric at the time that an agent has been hired by the principle. There arises a need for the application of a variety of mechanisms in the course of aligning the interests of the two parties. The mechanisms have a link to attempts of motivating the agent towards the directions of meeting the needs of the principal. Such mechanisms may include offers of commissions or rates, sharing of profits, provision of efficient wages, posting of a bond by the agent, fear of being fired among others. The principal agent problem prevails in the situation of a relationship of an employee to the employer. A good example is the situation that stakeholders in corporations hire their top executives (Ehrbar, 1998).

Illustration:

Agency Theory Basic idea (P: Principal, A: Agent)

The issues of the principal-agent problem revolve around motivation of one of the parties to work for the interest of the other party. The compensation made by the principal to the agent for the purpose of encouraging the agent towards performing specific acts that will be beneficial to the principal while they are of cost to the agent is the core element of the principal agent theory. Some performance elements whose observation is costly are the duty of the agent but the beneficiary is the principal. This case applies to majority of the contracts that are agreed upon in the context of uncertainty, risk and information asymmetry. The principal has little information about the extent of satisfaction to the contract. The solution associated with the information problem, which has a close correlation with moral hazard problem is to ascertain to the highest degree that the most appropriate incentives have been put in place to entice the agent act in the best interest of the principal. Applying the game theory in this scenario, the game rules require to be altered in a way that the predicted rational choices of the self interest of the principle are at par with the desired choices by the principal (Deci & Ryan, 2000).

Considering employment contracts, all forms of contracts form a dominant approach that guides the restructuring of incentives. This is achieved through close to optimal connectional information concerning the performance of the employee in relation to the compensation required for that level of performance. By doing so it is important to account for the existing disparities of information relating to the individual employee performance, their potential capability of bearing possible risk and their potentials in the manipulation of the methods of evaluation. This leads to a significant variation in the structural details associated with specific contracts. The variations are evident in mechanisms such as the piece rates, the options of shares, the extent of promotions, profit sharing, discretionary bonuses, efficiency wages, and deferred compensation among others. These are the important mechanisms that are considered at the time of employment of the agent (Qiang & Qiao, 2010).

Based on this argument, the commonly adopted system of remuneration of sales people is through commission, the production workers are paid hourly wages on a daily basis; the office workers are paid a salary on once or twice a month and in case of overtime the salary is calculated at a higher rate per hour in relation to their monthly salary.

The application of the mechanisms is diverse in the “primary” and the “secondary” sectors of the economy. The characteristics of the “secondary” sectors are short term relationships of employment, absence of possible internal promotion prospects and the wages are primarily determined by the market forces. The nature of occupation in this sector is the unskilled or low skilled jobs and the attached conditions are low levels of skills, low levels of earning, impermanence of job, an easy entry and low level of returns to past experience and education (Bènabou & Tirole, 2003).

Significant contributions to the extent of variation in the structures of incentives along with the mechanisms of supervision are attributed to the variations to the extent of intrinsic psychological satisfaction that are associated with diverse work types. According to the arguments of psychologists and sociologists, different people show different levels of pride as a result of the work that they do. The psycho- social compensation that they develop may be destroyed as a result of the introduction of a remuneration that is based on performance. This is because the exchange relation of the employer to the employer becomes narrowly economical and therefore causing a disruption of the social exchange potential (David, 2005).

The guiding motivating factors in the context of employee motivation theory are important in resolving the principal-agent problem which include achievement, advancement, pressure, fear and striking the balance of the others.

Achievement is a great factor that determines the level of motivation of the employee. The objective of achievement is the actual motivator of the employee. The employer therefore avail this factor through the establishment of challenges that the employee should meet. The application of this factor of motivation by the employer is associated with offering of incentives such as cash pay or promotion. In as far as the employees are concerned; the incentive is taken to be a bonus to compensate for the achievements and the target that the employer has set.

Advancement of the employee is yet another factor that governs the level of performance. Most of the employees are inspired towards climbing the ladder in their place of work. This causes them to work extremely hard in attempt of pleasing their superiors and attract their attention aiming at promotions. This nature of ambition among some employees may be at times be risky. Depending on the efforts and the ambition of the employee, the superiors stand at a risk of losing job incase the progress of the employee is perceived to be very rapid by the employer. This employee can also be manipulated as an asset to the company out of the hard work if only the superior is very cautious when handling such an employee.

Pressure is another important factor of motivation driving employees towards positive performance in their place of work. A few employees in most organizations are able to thrive properly when working under pressure. This factor is therefore intentionally latent in the behavior of the employee. Most of the pressures are loaded internally by the employee compelling him or her to strive even harder.

In some cases, the employer may utilize pressure to gauge the performance of the employees. On the other hand however, this factor is not always productive as it may lead to undesirable outcomes. This fact is based on the fact of a threshold that all people have and a lot of pressure may result to a breakdown therefore ruining the performance of the employee.

Fear is another factor of motivation in the work place and most of the employers capitalize on this factor to motivate their employees to perform to their expectations. Acts of intimidation are constantly directed to the workers as they are aware that their services may be terminated at any time that the employer feels that they are unsuccessful and unproductive to the extent of meeting the targets of the organization. This factor of motivation may also be unproductive if directed to an employee who is weak in coping with stressing situations.

The secret to the best approach of positively motivating the employees rests on balance. It is the duty of the employer to take in to consideration that the employees are entitled to varied inclinations. Im a similar manner that satisfying all the requirements of all employees at the same time is difficult, the management has the duty of identifying a system that facilitate for the integration of all possible features related to the motivation of employees. This is the only approach to achieve sustainability in the growth and development of the company (Knghts & Willmott, 2007).

Conclusion

Measuring employee performance

Business proposal experts argue that the success of any organization is entirely dependent on the techniques and methods put in place for the management of employees in part particular organization. This is the responsibility of human resource managers to ensure that there is a correct structure for human resource development for training of the workers. The management should account for the ways that the employees are recruited into the organization, the nature of the quality of services that they are given, ways through which the company helps the employees develop their own interpersonal skills as well as their own development of leadership skills

The measurement of the performance of the employees in the situation that drawing of straightforward connection of performance to profitability involves standard setting that are used in the judgment of performance. This may follow a comparison of an employee performance to that one of a peer in the same profession. This situation of course requires consideration of diverse exogenous circumstances that affects a particular employee. It may also be productive to use the performance of the same employee of a previous period to serve as the standard for comparison.

References

Bènabou, R. & Tirole, J. (2003). “Intrinsic and Extrinsic Motivation,” Review of Economic Studies, 70: 489-520.

David, K., (2005). British Journal of General Practice. available at HYPERLINK “http://www.ncbi.nlm.nih.gov/pmc/articles/PMC1562336/” http://www.ncbi.nlm.nih.gov/pmc/articles/PMC1562336/ accessed on 21st November 2010.

Deci, E. & Ryan, R.M. (2000). “Self-Determination Theory and the Facilitation of Intrinsic Motivation, Social Development, and Well-Being,” American Psychologist, 55: 68-78.

Ehrbar, (1998). The real key to creating wealth. New York- Wiley

Knghts, P., & Willmott, R., (2007). organizational behavior and management, N Y, Plenum.

Qiang, K. & Qiao, L., (2010). “Information-Based Stock Trading, Executive Incentives, and the Principal-Agent Problem”. Journal Management Science archive Volume 56 Issue 4. available at HYPERLINK “http://portal.acm.org/citation.cfm?id=1755993.1756000” http://portal.acm.org/citation.cfm?id=1755993.1756000 accessed on 21st November 2010.

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