agency problem

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The difficulties encountered when a principal delegates a task to an agent. The agency problem arises when the principal and the agent have different objectives and there is asymmetric information and an incomplete contract. The asymmetric information prevents the principal from perfectly monitoring the agent, and the incomplete contract makes it impossible to determine what will occur in all possible contingencies. The principal cannot therefore ensure that the agent always chooses the action the principal would wish to see chosen. Agency theory determines how contracts can be designed to ensure that these problems are best mitigated.

Subjects: Economics.

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