When we read “The Courtship of Miles Standish” in grade school, I had not yet studied economics, so I didn’t understand the theory underlying John Alden’s quandary or that Priscilla Mullins’ famous suggestion to “speak for yourself, John” constituted “collusion” with an “agent” against a “principal.”
Last week, however, on seeing breaking TV news that the local Catholic Archbishop had resigned, just after my wife and I had watched “Last Tango in Halifax,” it was clear that the local news and the BBC romantic comedy shared a common element. Both centered on what social scientists call “the principal-agent problem.”
I don’t mean to trivialize the tragic social problem of sexual abuse by grouping it with a TV comedy. Rather, I aim to show how broad a range of human behaviors are included in the phenomenon of principal-agent problems. These are pervasive and, among other harms, undermine the economic efficiency of a society.
This phenomenon arises when someone, the “principal,” needs something done but cannot accomplish it alone. So an “agent” is hired to work to meet the goals of the principal. However, circumstances can pose incentives to such agents for them to act in ways that may be in their own best interests but run counter to those of the principal.
One principal, the bashful soldier Miles Standish, enlisted the help of an agent, John Alden, to propose marriage to Priscilla Mullins.
But the young woman, maximizing her own satisfaction in life, or what economists call “utility,” preferred Alden as a mate and encouraged him to defect on his promise to represent his friend Standish. Agent Alden might have been better off speaking for himself, but that hurt the principal he had promised to represent.
The plot of “Last Tango in Halifax” revolves around a similar romantic dilemma, a besotted young couple don’t connect for 50 years because a friend entrusted to deliver a message wants the young man herself and discards the letter.
Which brings us to the Archdiocese, where the drama is tragic, but familiar. Some priests sexually abused parishioners, both children and adults. Their supervisors in church hierarchy allegedly acted to protect their institution and the perpetrators at the expense of the victims. A new archbishop is named after this has been unfolding for more than a decade and at a time when it is clear that sexual abuse by clergy is the greatest challenge the church has faced in a century.
Clearly addressing the problem is an important task. But the new archbishop then seemed to double down, ignoring warnings and exhibiting a remarkable ability to avoid the glaringly obvious and to “forget” key decisions and meetings, according to facts laid out by the local county attorney. The upshot was continued victimization of youth, an even more damaged public image for the Roman Catholic church, much well-justified anger and hurt among faithful parishioners and potential financial liability that will cripple the diocese’s ability to accomplish its mission well into the future.
Unfortunately, this level of failure is common in the corporate world, and that is from where most textbook illustrations of “agency” problems are drawn.
At global insurer American International Group, top management let a London-based financial derivatives trading arm take on financial risk to a degree that eventually eliminated all value for shareholders. Ditto for the mortgage-backed-securities trading arm of Bear Stearns. Ditto for Lehman Brothers. Ditto for Baring Brothers, which let a trader in his mid-20s put the bank on the hook for over $200 million some 20 years ago. Indeed, it is hard to find a major investment or financial trading firm that has not experienced such “principal-agent” problems.
More generally in the corporate world, the failure of hired management or even boards of directors to act in accordance of the interests of stockholders is pervasive, and is an important source of economic inefficiency.
Theoretically, corporate managers are hired by the firm’s owners to manage its affairs so as to maximize the present value of the stream of income that the company will generate over time.
But there are many situations where such hired agents instead maximize their own income or power or status at the expense of the shareholders, and often the firm’s customers and employees as well.
This is common in large corporate mergers. The key problem from the point of view of society as a whole is not that principal-agent problems merely are a zero-sum game in which one group gains at the expense of another. It is that they usually are a negative-sum game in which the losses of the losers are greater than gains of the winners.
When a CEO fails to make needed long-term investments so as to bolster apparent short-term earnings and thus gain a bonus, it is not just a transfer from stockholders to himself.
Rather, it means that society as a whole will use resources less efficiently. There will be fewer goods and services to meet the needs of society than would be possible if the incentives to make the bad decisions did not exist.
It is much easier to identify principal-agent problems than to remedy them.
Government regulations have proved bad at rectifying problems of corporate governance that cost our economy hundreds of billions of dollars.
And some innovations make things worse. When large financial firms like JPMorgan or Goldman Sachs were partnerships rather than publicly-traded corporations, there were fewer incentives for destructive risk-taking than now.
A KNOTTY PROBLEM
The problem is particularly knotty when it is not clear who the principal is. Does an archbishop serve the thousands of Catholics in the pews or the cardinal, pope and other members of the hierarchy above him?
Yes, in virtually every Christian denomination, doctrine is that clergy and laity alike serve God. But on a day-to-day basis, the duty of the clergy to the members of the church is clearer in Quaker and Congregational groups than in more hierarchical ones.
Principal-agent problems are so pervasive and cross so many types of organizations, for-profit, nonprofit, social, civic and fraternal, that much more could be said.
And such problems in government constitute an enormous topic themselves.
Solutions may be difficult, but increased public understanding of why and how the phenomenon presents itself is at least a step ahead.
Reach economist and writer Edward Lotterman at email@example.com.