Principal–Agent Problem
Michael Jensen & William Meckling · 1976
"The one deciding is rarely the one bearing the consequences."
A principal hires an agent to act on their behalf — shareholders hire executives, homeowners hire contractors, citizens elect officials. The agent has more information and different incentives, so their decisions systematically diverge from what the principal would choose. Every institution runs on layers of this.
The fix isn't to eliminate agents — you can't — but to reduce the gap: better information for the principal (audits, dashboards), aligned incentives (equity, bonuses tied to real outcomes), and skin-in-the-game where possible. Even so, some misalignment always remains; the design goal is to make the residual harmless.
Why do publicly traded companies use stock-based executive compensation?
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The explanation above is written with AI assistance. These are the originals — go to them to check it.
- Theory of the Firmpaper
The French Garden and the English Garden
"New systems are usually built like French formal gardens — a geometry imposed from above that flattens whatever was already there — when they could instead be built like English landscape gardens, which study the existing terrain and work with what's already load-bearing."