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Principal-agent problem

1- What are the essential features of a principal-agent problem?

2- Why is "hidden information" a crucial element of any principal-agent problem?

3- Show that, optimally in a principal-agent problem, the agent is rewarded if the signal observed is likely given the action the principal desires of the agent, and unlikely given any different action, while the agent is "punished" in the opposite situation.

4- In the context of a principal-agent problem, explain the "incentive intensity principle" and the "equal compensation principle".

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The response addresses the queries posted in 907 words with references.

// Principle Agent Problem is a big problem facing the businesses. Here in we discuss various questions related to Principle Agent Problem. The first question discusses the various features of principle agent problem //

Features of Principle Agent Problem

Principle agent problem arises in the conditions of incomplete information and for this problem agent is hired by the principle. It is a kind of game, in which one player is known as principle and another one is agent. It is the mechanism of stimulating one to take action on behalf of the other. This problem occur, when principle reimburse the agent to perform something that is useful and compatible to the principle but expensive to the agent. It is also known as agency dilemma, because uncertainties are associated with this problem. This problem is found mostly in the employer or employee relationship. Agents have different functions than principle and these functions are known as utility functions (Principal-Agent Theory, 2008).

Principle agent problem is based on designing an incentive scheme, which shows a theoretic summary of condition. It deals with the complexities, which occurs due to lack of information. Through the actions of agents, the principle can perform more effectively. Solution to the problem depends on the relationship between principle and agent. There are differences in the incentives of principle and agent. This relationship can be defined as a contract between ...

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