Definition
The principal-agent problem describes the difficulty a principal faces when delegating a task to an agent who has different goals and better information. Because the principal cannot perfectly observe the agent's effort or knowledge, the agent may act in its own interest rather than the principal's.
Classic examples include shareholders (principals) hiring managers (agents), voters delegating to politicians, or a client hiring a contractor. Each relationship rests on trust the principal cannot fully verify.
Why it matters
How it works
The problem has two faces. Hidden action (moral hazard) means the principal cannot see how hard the agent works. Hidden information (adverse selection) means the agent knows things the principal does not.
Solutions try to realign incentives or reduce the information gap: performance-based pay, equity stakes, monitoring, audits, reputation, and well-structured contracts. None fully eliminate the problem, so a residual agency cost usually remains.