Principal Agent Theory

Question 1

What is the game theory?

Answer 1

Game theory is the study of mathematical models of strategic interaction between rational decision makers.

Question 2

What is the Principal Agent Theory (PAT)?

Answer 2

• Collaboration of two persons, who have a contract (employers + employee) with each other
• Agent (contractor/Unternehmer) + Principal (contractor and client)
• Goal is that the rational choices of the agent coincide (deckt) with what the principal desires (resolve problems)

Question 3

What is the difference between cooperative and non-cooperative games?

Answer 3

cooperative games = a game of competition between players due to the possibility with external enforcement of cooperative behaviour (it is regulated by rules/contracts)

non-cooperative games = no possibility to form an alliance (Bündnis) or the agreements need to be self-enforcing (for example - doping); rock, paper, scissors

Question 4

What is a zero-sum game?

Answer 4

each participants gain or loss of utility is exactaly balanced by the losses or gains of the utility of the other participant

Zero-sum is a situation, often cited in game theory, in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero.

Question 5

What is the difference between simultaneous game and sequential game?

Answer 5

simulataneous game = each player chosses his action without knowing the action of the other player

sequential game = played by turn, (for example) chess, by move after move you can calculate the outcome

Question 6

What is the perfect information game?

Answer 6

= perfect competition. The players , consumers have all the perfect and necessary information

Question 7

What is the PAT problem?

Answer 7

The asymmetric information between principal and agent produces problems
- that can lead to opportunistic behaviour from both sites (maxmise the profit)

Question 8

What is meant by adverse selection?
What are possible solutions for the problem?

Answer 8

Adverse selection happens before the closed contract.
hidden characteristics of the agent can cause problems because it can happen that he/she is acting in a opportunistic behaviour

to reduce the dilemma/asymmetric information:
a) Signaling: certificates
b) screening: training
c) self-selection

Question 9

What is meant by Moral Hazard?
What are possible solutions for the problem?

Answer 9

a) Hidden Action: the agent is doing action which you cannot see as a principal
b) Hidden Information: the agent hides information after the contract was made
 Agent can maximise its self-interest and that is often against the principal’s opinion!
Examples: performance of event organisations

solution:
a) Hidden Action  Monitoring (that’s is however limited)
 bonding (contract)
b) Hidden Information:  incentives

Question 10

What is meant by hold up in the Agency Theory?
What are possible solutions for the problem?

Answer 10

• pre-investement of either the agent or the principal is happening before the contract is closed
• problem: it can lead to a hidden intention in order to put pressure to the counterpart
  –> negogiate prices, conditions etc.

a) Guarantees (written, contract)
b) vertical integration (buy the whole company that should cooperate with you)