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Principal-Agent Problem Mccubbins,)“Admin.)Procedures)as)Instruments)of)Political)Control)Nielson)&)Tierney,)“IOs,)Agency)Theory)and)WB)Reform”)Principal)Agent.Problem.• Principal:.authority,.delegates.tasks.to.agent,.have.resources.• Agent:.subordinate,.expertise,.more.time.• Problems:.o 1).Desires.and.preferences.of.principal.and.agent.may.not.be.aligned.o 2).Agents.can.hide.information.and/or.actions.Solutions.• 1).Incentives..contracting.o Positive:.rewards,.monetary.compensation,.bonus.o Negative:.sanctions,.fines,.extra.duties.o Problems:. Agent.can.still.hide.information.and/or.actions;.principal.still.does.not.have.perfect.information. Contracts.are.never.perfect.• 2).Monitoring.(overseeing,.supervising).o i.e..Security.cameras,.audits.o Costly..money,.time.• Costs.of.reducing.slippage.has.to.be.tra ded.off.by.what.the.slippage.could.be.o Settle.for.less.than.100%.of.perfect.quality.work.Examples.• 1).Congress)&)Agencies.o A).Principals:.Congress.and.President.(sometimes).o B).Agents:.bureaucratic.agencies.o C).Concerns:. Agencies.create.laws.that.do.not.benefit.the.public. Unelected.officials.are.not.affected.by.public’s.opinion. Hidden.information.and.actions..“runaway.bureaucracy”. Either.do.nothing.(shirk).or.are.zealots.for.regulation.(over)regulate).o D).To.control.agents:. 1).Oversight. i.e..Audits,.Congressional.hearings. Problems:..• Actions.are.reactionary.(the.bad.event.already.occurred).o Fire)alarm.monitoring.=.interested.parties.alert.authorities.when.there.is.a.problem.• Costly..could.be.using.time.for.more.productive.purposes. Police.patrols.=.active.oversight. 2).Administrative)procedures:.guidelines.that.agencies.must.follow.when.executing.policies.(pgs..257)258). Makes.agencies.responsive.to.interested.parties.and.decreases.information.problem.• Elected.officials.can.now.put.the.oversight.on.auto)pilot. Maintains.coalition..creating.procedures.that.are.responsive.to.public.• 2).International)Organizations)(IOs).o A).Principal(s):.member.countries.of.IOs. Multiple.principals.=.problematic.bc.becomes.confusing.for.agent.when.each.principal.has.its.own.preferences..can.send.conflicting.messages.to.agent.(who.already.has.his.own.preferences).o B).Agents:.IOs.(i.e..UN,.WTO,.World.Bank).o C).Concerns:. IO.acts.contrary.to.the.preferences.of.multiple.principals. Getting.principals.to.agree.(collective.action.problem). Proximity.to.agent.determines.amount.of.control. The.closer.to.agent,.the.more.control.over.agent. .o D).To.control.agents:. Cut.funding.(sanctions). Screen.and.select.employees.of.IOs.Credible Commitment Problems General)Credible)Commitments)Noorudin,)“Coalition)Politics)Why.Commitments.May.Not.Be.Credible.• Cheap.talk:.you.can.say.whatever.you.want,.but.unless.there.is.enforcement,.or.cost.behind.the.promise,.it.may.not.be.fulfilled.• Time)inconsistent.preferences:.long)term.incentives.might.be.undermined.by.short)term.incentives.o Both.parties.can.have.incentives.to.commit.to.the.long)term.promise,.but.the.short)term.incentive.might.be.to.cheat.o Once.situation.changes,.preferences.change.o i.e..New.Years.Resolutions—.we.make.long)term.goals.for.self)improvement,.but.they.usually.do.not.last.very.long.because.short)term.preferences.get.in.the.way.• Use.commitment.devices.to.ensure.they.are.fulfilled.Governments.&.Investments.• Investors.want.low.taxes,.low.levels.of.regulation,.minimal.oversight.o Do.not.want.policies.to.be.rapidly.and.frequently.changing.• Politicians’.preferences.change.bc.of.circumstances.o i.e..Bush.promised.he.would.not.raise.taxes.during.his.presidency..recession..taxes.increased.• Politicians.can.flat.out.lie.• Frequent.overturn.of.leadership.(especially.in.democracies)..those.who.made.previous.commitments.leave.office..try.to.set.long)term.policy.while.they.are.in.office.(renegotiation)proof).Overcome.Commitment.Problems.• 1).Delegate.o Hand.over.enforcement.of.commitment.to.a.third.party.who.does.not.share.the.preferences.of.those.involved. i.e..Impartial.courts.o Problems.for.governments.bc.many.times.the.govn’t.is.the.third.party.enforcer. A.state.strong.enough.to.enforce.is.also.strong.enough.to.violate..o i.e..Independent.central.bank.(no.political.ties)..helps.maintain.a.stable.rate.of.inflation.o i.e..Independent.judiciary..convinces.citizens.that.rights.will.be.protected.o Difficult.at.the.international.level..• 2).Reputation.o i.e..Companies.strive.to.maintain.a.good.reputation.to.keep.customers.o i.e..Politicians.who.are.the.worst.at.breaking.promises.will.be.unpopular.with.constituents.o Politicians.face.audience.costs.• 3).Make.reversal.difficult.or.impossible.o Burn.bridges.behind.you,.burn.your.ships,.cut.off.your.exit.o Cut.communication.Institutional.Constraints.• By.virtue.of.how.policies.are.made,.policies.can.be.more.or.less.credible.• 1).Checks.and.balances.o i.e..Veto.points.• 2).Coalition.governments.(multiparty.system).o One.party.is.big.enough.to.form.the.government.o Minority.party:.party.runs.the.govn’t.without.being.the.majority.o In.Coalition.govn’ts.and.minority.party.govn’ts,.another.party.has.to.also.sign.the.bill. Partisan.veto:.moderates.policy;.makes.it.difficult.to.pass.laws;.laws.that.are.past.are.very.moderate.• 3).Gridlock.• Govn’ts.with.gridlock,.coalition.govn’ts.are.more.attractive.to.investors.bc.the.rules.may.not.change.very.much.Information & Markets 5.Akerlo,)“The)Market)for)‘Lemons’:)Quality)Uncertainty)and)the)Market)Mechanism”)Wheelan,)“Economics)of)Information”)Information.&.Markets.• No.such.things.as.perfect.information.• There.are.barriers.to.information.(i.e..trustworthy.business.partners?).Information.Problem.Example.—.Market.for.“Lemons”.• Seller.knows.more.than.buyer.about.product.or.service.• New.vs..used.cars.and.good.vs..bad.cars.(“lemons”).• Good.and.bad.cars.are.priced.the.same..sellers.want.to.sell.the.bad.cars.for.as.much.as.the.good.cars.o Customers.cannot.distinguish.good.cars.from.bad.cars.because.priced.the.same.o Incentive.to.sell.good.car.decreases..sellers.of.good.cars.leave.the.market..market.left.with.lemons..consumers.assume.that.all.cars.left.are.lemons.and.no.one.wants.to.buy..market.potentially.collapses.•


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FSU CPO 3930r - Principal-Agent Problem

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