Principal-agent problem
Also known as: Agency problem
How do you get someone to act in your interest when you can't watch their every move?
What it means
The challenge that arises when one party (the principal) delegates work to another (the agent) whose interests diverge and whose effort or information cannot be perfectly observed. Because the agent may pursue their own goals — shirking, taking hidden risks, or exploiting private knowledge — the principal must design incentives, monitoring, and contracts to align behavior, trading off risk-sharing against effort motivation. It generalizes moral hazard and adverse selection into the central problem of organizational and contract design. It matters everywhere delegation occurs: shareholders and managers, employers and employees, voters and politicians, patients and doctors.
Examples
Shareholders want long-term value, but a CEO paid on yearly results may chase short-term gains that hurt the firm later.
You cannot watch the builder's every hour, and he is paid by the day — so the job takes days. Fixed-price quotes exist to change that arithmetic.
An estate agent earning a small slice of the sale price would rather close this week than squeeze out the last few thousand; the extra fortnight costs him more than his commission on it.
First described in Jensen & Meckling (1976); Ross (1973).