On the Consistency of the First-Order-Approach to Principal-Agent Problems

Abstract

This paper revisits the principal-agent model with moral hazard when its solution is obtained invoking the first-order-approach. We show that the solution can be economically inconsistent even when “sufficient conditions” ensuring its validity ([1,2]) hold. To be more precise, we provide examples where is impossible to find Lagrange multipliers validating the approach. The correct solution to the problem provides a rationale for option-like contracts and minimum payments

An Application of Principal Agent Theory to Contractual Hiring Arrangements within Public Sector Organizations

“…[3] [15] [16]. Thus, a symbiotic relationship evolves where both parties' interests should have alignment and the development as noted in the Introduction of a "second-best contract" see [4] [7]- [9] and others.…”

“…The aspect of contractual incentive design in principal-agent relationships is extremely important and is a responsibility for principals. In fact, principals need to ensure as rational utility maximizers that agents are provided with comparable and competitive compensation and other incentives in their agreements [4] [17] [18]. These will enhance agents' acceptance of their terms and conditions at the signing off of these agreements and their motivation to commit to expected roles after the contracts have been accepted.…”

“…Others assert that "quantitative solutions are not as readily available from implicit equations of sharing rules". Thus, therein highlights a few of the challenges and economic risks posed by its application to contractual hiring arrangements within public sector organizations [4] [10] [21].…”

“…Therefore, Principal Agent Theory with the implications of agency problems underscores the bedrock of analyses that can be generated in regard to contractual arrangements [4]- [6]. Such arrangements are ideally intended to be mutually beneficial to both principals and agents in spite of risks such as adverse selection, asymmetric information and moral hazard.…”

“…the principals (as employers) and the agent (as employees)-are able to share the outputs. The intent by the former is to glean the maximum amount of input not easily observed and exerted by the agents, see [4] [7]- [9] and others. Therefore, this theory is relevant for public sector organizations, practitioners and economic researchers as they explore the significance of agency problems in economic contract arrangements such as tangible incentives in light of their efficiencies.…”