A key aspect of the principal-agent problem is that
A) the principal cannot perfectly monitor the agent's actions.
B) the principal can perfectly monitor the agent's actions.
C) the output level does not depend on the agent's actions.
D) the principal is always risk averse.

Question

Quizplus · Accepted Answer

The principal-agent problem arises when the principal hires an agent to carry out a task on their behalf, but cannot perfectly monitor the agent's actions. This creates a potential conflict of interest between the two parties, as the agent may act in their own self-interest rather than the principal's. Choice B is incorrect as the principal cannot perfectly monitor the agent's actions, which is the root cause of the principal-agent problem. Choice C is also incorrect as the output level is affected by the agent's actions - this is why the principal hired the agent in the first place. Choice D is irrelevant as risk aversion is not a defining feature of the principal-agent problem.

A Key Aspect of the Principal-Agent Problem Is That