The Principal Agent Problem

I read something or other last week about “skin in the game”, maybe some Taleb stuff, and it stuck with me…I’m now wondering if the principal-agent problem and skin-in-the-game aren’t two aspects of the same basic problem.

The principal-agent problem:   Principal P hires Agent A to solve some problem.   But…what is good for P is different than what is good for A.  So, P ends up paying A to do what A wants, rather than what P wants.

This is an enormous problem in stock trading (bonus structures), corporate management, representative democracy, and roughly any form of political organization where someone makes decisions nominally in someone else’s best interests.

Skin-in-the-game is theoretically a different problem.  When unelected regulator R makes a rule that impacts Business B and Consumer C, they almost always make bad decisions because the decision they make doesn’t impact them.   They may be trying to make a best decision, but they have no skin in the game, and therefore their level of effort is less than optimal.

And yet a third problem in the category is deciding / paying mismatch.  The fundamental error in the insurance industry (and the education industry) is a mismatch between who decides and who pays.   In insurance in the USA, doctor D decides without paying attention to costs, and Insurance company I pays .   This leads to a bit of a problem on costs.  In Europe, the bureaucrat decides, and the taxpayers pay.  The costs here appear to increase at the same rate as in the US, but from a lower baseline.   In the Kaiser system, the insurance company and the doctors are a single group, so the decide/pay line is somewhat less bad.   In Singapore or in HSAs, the individual decides and pays…which is why it’s the best cost-management system for health costs in the world, along with some of the best outcomes.

In all 3 cases, there are individuals (A, R, D) who are making most of the decisions (in a context) that impact the other players in the scene (P, B, C, I), and whose motivations aren’t aligned.

I think there’s a lot of systems with this structural problem.   Might ought to look at the systems and run analysis.

Who decides?
Nominally, who is this benefiting?
What factors (feedback systems) are in play to make sure that the decision benefit the nominal beneficiaries?

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