Introduction

In the previous two chapters we analyzed market relationships when, at the time of contracting, one party has private information concerning the quality of the traded good. Now we turn to bilateral contracting problems when relevant private information is expected to emerge after contracts have been signed. This problem has been named the problem of postcontractual opportunism, or simply the principal–agent problem.

Postcontractual opportunism is endemic to relationships that involve the delegation of activities to another party. The prototypical example is the employment relationship, where a person called the principal hires another person to act as his or her agent. But there is an abundance of other applications. For example, a principal–agent relationship exists between a landowner and a farmer, a car owner and her no-fault insurer, a doctor and her patient, a lawyer and her client, a borrower and a lender, and a regulator and a public utility, to name just a few.

It is useful to distinguish between two kinds of informational asymmetries that may emerge in a principal–agent relationship: hidden information and hidden action. If a manager is put in charge of sales, in the process of doing his job he typically acquires a better understanding of the firm's market; thus, he acquires private or hidden information.