Political Science 200A
Week 9
Hierarchy: Principal‐Agent
and Relational‐Contracting Models
I. Structure of Principal‐Agent Relations
A. In Economics: Principal hires Agent to perform task
[a] Demsetz: Delegation (conditional transfer) of property rights
[b] PoliSci: Delegation (conditional transfer) of decision rights (authority)
Principal
B. Key terminology
[a] Principal
[b] Agent
[c] Delegation
[d] Accountability
Delegation
Accountability
Agent
II. Parliamentary vs. Presidential
A. Accountability = removal not selection
Strom: “the decisive property is ex post accountability, not ex ante selection” (p. 266)
B. Agent is accountable to principal if [1] agent is obliged to act on the principal’s behalf and [2] the principal is empowered to reward or punish the agent for his performance in this capacity. (p. 267)
C. In parliamentary system [1] a single chain of principal‐agent relationships and [2] greater reliance on ex ante screening over ex post monitoring
III. Agency Losses (Agency Problems)
A. Incentive incompatibility
B. Information asymmetry / incomplete information
C. Consequences:
1. Adverse selection
2. Hidden action
3. Moral hazard
4. Agency loss
5. Shirking IV. Minimizing Agency Loss
• Imperfect and costly remedies
[1] Screening / Selection mechanisms
– 1. Incentives to misrepresent abilities
– 2. Reliance on signals IV. Minimizing Agency Loss
[2] Contract design
– 1. Creating incentive compatibility
• Compensation scheme
• How is this done in a democracy?
– 2. Objective indicators (signals) of success
– 3. Problems of multiple objectives
– 4. Problem of incomplete contracts
• A contract cannot cover all contingencies
IV. Minimizing Agency Loss
[3] Monitoring and Sanctioning
‐1. Reporting Requirements
‐2. Monitoring costs
‐3. Problems in creating incentives for monitors
‐4. Police patrols vs. Fire alarms (McSchwartz)
Police patrols = centralized, active, and direct
Fire alarms = decentralized, passive, and indirect
Efficiency
[4] Institutional checks (checks and balances)
V. Complications in the P‐A Model
A. Multiple Principals and Agents
1. Multiple principals = Potentially competing goals
2. Multiple agents = Potential for collusion
B. P‐A Chains
‐Attenuation of accountability
Ronald Coase (1910‐ )
Educated at London School of Economics
1964 University of Chicago
1991 Nobel Prize in Economics
“The Nature of the Firm” (1937) (Coase theorem)
Transaction Costs
Costs of Management
Oliver Williamson (1932‐ )
Educated at Carnegie‐Mellon
1988 University of California Berkeley
2009 Nobel Prize in Economics
I. Williamson: Hierarchy vs. Market
A. Explaining Economic Organization, Governance Structures, and Boundaries Between Firms and Markets
B. Explained by efficiency considerations
1. Transaction Cost economies
2. Governance Cost economies
I. Williamson: Hierarchy vs. Market
C. Asset Specificity in Transactions
1. Site specificity
2. Physical asset specificity
3. Human asset specificity
D. Consequences of Asset Specificity
1. Seek continuing relationship
2. Vulnerability to opportunism
II. David Lake
A. Explaining Choice among Security Relationships
B. Analytic Assumption
1. Efficiency
2. Marginal benefit from more hierarchy equals
Marginal governance cost
II. David Lake
C. Key Independent Variables
1. Joint Production Economies
2. Expected Costs of Opportunism
3. Governance Costs
II. David Lake
C. Key Independent Variables
1. Joint Production Economies in Security
[a]. Scale economies vs. Marginal costs of projecting power over greater distance
[b]. Division of labor / Specialization
[c]. Positive externalities
2. Expected Costs of Opportunism
3. Governance Costs
II. David Lake
C. Key Independent Variables
1. Joint Production Economies
2. Expected Costs of Opportunism
[a]. Abandonment (like adverse selection)
[b]. Entrapment (like moral hazard)
[c]. Exploitation (appropriable quasi‐rents)
Asset specificity may increase exploitation by others
3. Governance Costs
II. David Lake
C. Key Independent Variables
1. Joint Production Economies
2. Expected Costs of Opportunism
3. Governance Costs
[a]. Costs to subordinate power
[b]. Costs in maintaining safeguards on dominant
[c]. Coercion