Principal Agent Theory at Work

Thursday, July 20th 2023

The simplistic concept of a "team" assumed identical objective functions of all members of the firm (employees).

Under this assumption, the problem is the management of decentralized information.

But then reality sets in: everyone has a different objective function. Enter the principal-agent problem. (unpack below)

Delegation under principal-agent has a few elements that we see play out in work all the time:

And that's within the 'hardened' four walls of a traditional firm.

Add in remote, that "check performance" can be harder (unless designed for this, which is possible).

These come to light as problems magnified, but also with a potent solution, with web3.

Imperfect information and differing objective functions can be solved with incentives.

Incentives already exist in the firm. Do what we want you stay and get promoted. Do what we don't and you are gone.

So the part missing in this version of principal-agent theory but very very present in traditional work is the power asymmetry, not information asymmetry.

This has been enforced by regulation, employment law, and the imbalance in resources to prosecute based on the law.

One approach has been the "open start-up" found in remote-first or remote-only companies.

Here, the thesis is that any information that would be valuable for performance management is visible not only to the principal, but to anyone who wishes.

It's not a bad idea if it can be executed. Open repos, public metrics, even video-recorded meetings all provide much more transparency. It can make for a better culture of self-imposed accountability and moving more quickly from low-to-high trust.

It's not quite the same, however, of objective evaluation of performance.

Some of the ideas behind smart contracts is changing that by relying on immutable data on the blockchain.

How far can this go in terms of disrupting the traditional concept of the firm?

I believe DAOs have the potential to do this, and are doing so by trying to add incentives in the mix while reducing the power asymmetry.

This is along the lines of Composable Product Maanger but extended to all functions, roles, and titles.