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Multifaceted aspects of agency relationships

University of British Columbia

Agency theory has been used to examine the problem of stewardship of an agent who makes decisions on behalf of a principal who cannot observe the agent's actual effort. Effort is assumed to be personally costly to expend. Therefore, if an agent acts in his or her own interests, there may be a "moral hazard" problem, in which the agent exerts less effort than agreed upon. This dissertation examines this agency problem when the agent's effort is multidimensional, such as when the agent controls several production processes or manages several divisions of a firm. The optimal compensation schemes derived suggest that the widely advocated salary-plus-commission scheme may not be optimal. Furthermore, the information from all tasks should generally be combined in a nonlinear fashion rather than used separately in compensating a manager of several divisions, even if the monetary outcomes are statistically independent. In situations where effort is best interpreted as time, effort can be viewed as being additive. The analysis in this special case shows that the nature of the outcome distribution, including the effect of effort on the mean of the distribution, is critical in determining whether it is optimal for the principal to induce the agent to diversify effort across tasks. These new results and the already existing agency theory results are applied to the sales force management problem, in which the firm wishes to motivate a salesperson to optimally allocate time spent selling the firm's various products. The agency model is also expanded to allow for the agent's observation of the first outcome (which is influenced by the agent's first effort) before choosing the second effort level. The optimal compensation schemes both in the absence of and the presence of a moral hazard problem are derived. The behavior of the second effort strategy is also examined. It is shown that the behavior of the agent's second effort strategy depends on the interaction between wealth and information effects of the first outcome. Results similar to those in the multidimensional effort case are obtained for the question of optimality of diversification of effort when effort is additive.

Text

2010-06-13

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http://hdl.handle.net/2429/25642

Business Administration

University of British Columbia

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