Rationality, Incentives, and the Agency Dilemma
Moving along, to present an important concept from economics in this article, two assumptions will be presented in the course of this exposition. As is typical in Pulp Economics articles here at The Dark Wraith Forums, we shall advance the plot by featuring the activities of an average person whose life cannot help but be infused of economics. Along the way, we shall also set forth some terminology in a more or less formal way. A few terms to lay the groundwork must be provided at the outset, but first, the protagonist of this story must be introduced.
Percival Luntz has lived near Batavia his whole life. He graduated from high school back in 1994 and has worked in the area ever since. The best job he had was at the chemical factory over in Wyoming County, but that place closed its doors in 1999. A couple of wood mills still kept busy, but Percy couldn't keep up with the pace the foremen expected. He did some construction work, but not much new building had gone on in the whole area since so many men got put out of work when the factory closed. For a while, he was driving to Rochester to work at the mall, but gas prices eventually made the trip too expensive so he finally settled down to work at the Ice Kreem Kween at the corner of Jackson Street and Maple Avenue, where he's been for the past year or so.
Percy is a pretty solid worker. He was brought up by his mother since his father died in a fishing accident in 1988 when he was reeling in a walleye and fell out of the boat and drowned when he tried to net the thing. Percy's dad had instilled in him some good values, but it was his mom who got Percy to thinking right about being honest and working hard.
Not everyone at Ice Kreem Kween was like Percy, though. It wasn't Percy's business, of course, but Ned Stambaugh, who owned the Ice Kreem Kween, hired a lot of people, especially high school kids, who just didn't have what Percy's mother called "the work ethic"; but Percy did his job just fine, and at least at first, he figured it was up to Ned to know what was going on at the shop. If Ned didn't care, why should he? That way of thinking didn't sit well with Percy, though, and as time went on, he saw things differently.
In economics terminology, Percy is an economic agent. So is Ned, and so are all the other people who work at Ice Kreem Kween: each person has a set of incentives governed by what we describe as bounded rationality, which is to say that they, like all people, are genuinely rational in their decisions and actions, but those decisions and actions are made under constraints, four of which are significant in almost all situations.
Constraints on Rational Action
The first constraint on rational action is information. People who know Percy don't think a thing about the fact that his front teeth on both the top and the bottom look funny, but strangers kind of stare at him when he smiles because they're trying to figure out why those front teeth are so white compared to the teeth just to the sides of them. The truth of the matter is that those incisors Percy sports are false teeth: he lost his real teeth in an accident in 1991, when he was a sophomore in high school. It seems he and some friends were messing around out by the old, abandoned mine just off what's now called Fort Street. Percy's friend Joel, a scrawny kid with a knack for climbing and crawling in tight spots, had managed to work his way past a rusty steel barrier at the entrance to one of the mine shafts. Joel came back from his foray down that shaft with a box of blasting caps. They were as old as dirt, and that's what they were covered in, but Percy, Joel, and "Bruggie"that's what everyone called Harmon Bruegemandug out the dirt from the box and retrieved four perfectly good looking ones.
None of the boys had ever seen one of these things before, and they certainly didn't know how to make them blast, but Joel said he thought they were sort of like loud firecrackers. The boys went back to the repair garage Bruggie's dad ran, and they put the blasting caps on a table. Joel took a whack on one of them with a hammer, and nothing happened. Bruggie tried, too, but the thing just sat there. Joel and Bruggie banged on the thing several times each, but they got nothing for their effort. That's when Percy grabbed one of the other blasting caps and said, "Lemme try this": he put it against his lower front teeth and chomped down hard.
The thing went off like a gunshot. So did Percy's front teeth. Fortunately, even though his lower lip took a pretty good measure of the blast, it stayed attached, and Doc Gatshalt was able to sew it back on darned near perfectly. The dentist in town, Dr. Yoeman, couldn't do anything to save the teeth even though Bruggie found two of them on the other side of the garage. After Dr. Yoeman dug what was left of the roots out and gave Percy's gums some time to heal, he put in permanent falsies. They weren't the best but they took, and Percy looked pretty good for his photo at the Junior-Senior Prom the next year.
Even though Percy's uncle called him the "dumbest ass God ever made" for biting down on the blasting cap, Percy knew better. For one thing, he'd gotten more B's than C's in his freshman year of high school; but more to the point, he knew he'd learned a valuable lesson from nearly blowing his face off.
Percy wasn't dumb, and he certainly wasn't irrational; he just lacked the information about blasting caps he would have needed to make a better decision. He'd never seen one before, and he didn't understand the risks involved with pyrotechnics of any kind, since he hadn't grown up around guns or anything like them. His dad was a fisherman, not a hunter, so Percy didn't really even know about the force, heat, and pressure that can be created by things that have explosives in them. Percy biting down on the blasting cap wasn't irrational; it was, instead, an act committed under severely bounded rationality. From a financial economics perspective, Percy was rationally accepting risk for an expected returnthe thrill of having the cap explodebut his assessment of the risk was woefully lacking. In other words, people accept greater risk in order to get what they expect to be a better return; but in Percy's case, he did not yet grasp that lack of information is, in and of itself, a sourcemaybe the primary sourceof risk. Had Percy known that his ignorance was creating extreme risk, he might have considered any return he expected to get from his stunt not to have been worth it.
The second binding constraint on rationality is time. Ned, the owner of Ice Kreem Kween, was forever saying "time is money," but Percy knew this was a fact. That drive Percy had made clear to Rochester every day wasn't just draining money directly from his bank account; it was also taking away his ability to do something else with his time on the road. Percy kept thinking to himself on that long drive that he could be working in Batavia instead of being on the road for a couple of hours, and he'd be earning money instead of burning gas. Even if Percy could clear just five bucks an hour working at some local place, he was wasting about fifteen to twenty dollars every day just being on the road instead of working.
Percy was right on the verge of understanding the economics concept of opportunity cost: the cost of the most valuable alternative foregone by taking an action or using something. In fact, Percy really did grasp opportunity cost pretty well. He never went into the fancy grocery store in Batavia, a place called Shirkman's, because the prices were too high there; but the well-to-do people in town all went there, and their motivation was more than about the quality of the produce, meats, and other items on the shelves. It had much more to do with the opportunity cost of time: the wealthy people were willing to pay higher prices so they wouldn't have to wait in the ridiculously long lines at places like Walmart, where the prices are lower, but the lines are always stupid. The linesformally called "queues" in economics and industrial and systems engineeringrepresent a hidden, indirect cost: people who make low wages have a lower opportunity cost of time than wealthier people, and this is reflected in many behaviors, not just willingness to stand in long lines to save a couple of pennies.
But rich or poor, people are trapped by time. Percy had planned to take some classes at the community college. He never got around to it, and his plans to do so got fuzzier and fuzzier the more he made working full-time and then some. To an outside observer, Percy was not being all that rational by foregoing college, especially since he was a pretty bright fellow. But for Percy, attending classes, doing the necessary studying, and driving back and forth to school was part of the total costthe sum of direct and hidden costsand that total cost was going up and up as Percy made a better and better hourly wage as his productive life proceeded. The constraint of time was quietly but effectively forcing Percy to make choices; and even though the choices Percy was making might not have been "rational" in some grand scheme of a well-planned life, they were most certainly rational when considered in the context of the binding constraint of limited time that had to be allocated from day to day and week to week in his life.
The third constraint binding rationality is capitalspecifically, money. A whole lot of decisions seem irrational to an outside observer who has the money to do something "better." When Percy needed those new teeth, it would have been better if his mom had taken him to Rochester, where orthodontists could be found who do that kind of thing every day. As it was, though, Percy's mother couldn't possibly have afforded that kind of fancy work, so Dr. Yoeman took care of it (even though he really wasn't supposed to since he was just a dentist, after all).
Money can help people make the right choices. More to the point, lack of money can make people look like they're stupid, crazy, incompetent, or just plain lazy.
The fourth constraint on rational behavior is cultureculture in the large, culture at the level of the community, culture at the level of the family, its religious practices, its peculiarities, and its background. In Percy's case, this played out powerfully every day he worked. His boss, Ned, was hardly ever at the shop anymore. He let Percy run the place, even to the extent of taking care of getting cash money from the bank every morning and taking the receipts to the bank every evening. Percy could take a twenty or even a couple every so often, and Ned would never miss it. But Percy never did.
Percy's dad died while fishing, something he didn't have to do. No one in the family was all that thrilled about eating fish, and Percy's father could well afford to buy meat at the grocery store. Fishing wasn't a rational activity, except that it was a culturally sanctioned, almost required, behavior among men of his time and place. You either fished or you hunted or you did both; and if you didn't do anything like that, there might be something a little odd about you. Percy's dad didn't even think about the actual why of his hobby: he just did it, and he did it at least two or three times a month. Eventually, he got killed pursuing his hobby. As Percy would grumble years later, "He didn't even get the damned walleye," an expressed sentiment to which his mother sighed and nodded her head in agreement.
Rationality and Greed
Bounded rationality is still rationality; and in economics, one of the most rational of human instincts is greed. More is better than less, and more is preferable to less. If it comes down to you or me, I'll choose for me unless I think I can gain something really important by taking care of you first. Even if someone's going to die to save someone else, there'd better be a darned good reward in the afterlife.
If the Lord Jesus Christ came to a Christian and said, "Your life is pre-ordained that you should die and burn in the tormenting fires of Hell for all eternity," most Christians would dispense with the much-touted "purpose-driven life" right on the spot. If the Prophet Mohammed were to step in front of an Islamic suicide bomber and say, "I'm sorry, but that mullah who told you that blowing yourself up to kill some infidels would earn you brown-eyed virgins in Heaven was full of camel crap: you do this, and I'll personally see to it that Allah brings you back as a sand flea stuck in the dried turd on a goat's butt hair," the young bomber would very likely say something like, "Oh. Well, screw that then," and give up his plan to decorate the shopping mall with his shrapnel-infused viscera.
That's how economists see it, anyway. Greed is the motive force of life. Contrary, however, to what the character Gordon Gecko said in the movie Wall Street, greed is not "good." It isn't bad, either. It just is; and it is the fundamental reason people do just about everything they do.
This assumption of greed as both neutral and central in human action was the triumph of the so-called "father" of economics, Adam Smith, as he broke the ancient connection between religion as a guide to human action and instinct as the motivator of human action. Greed is not some "mortal sin"; greed is what makes people act rationally to benefit themselves. The "desirable" and the "desired" are not the same: the first is the realm of ideals, the latter is the realm of reality.
But the expression of greed, like all results of rational human action, is constrained by information, time, money, and culture. For some, greed compels taking without thought and without concern for reciprocation, accommodation, or larger issues of interpersonal consequences; for others, greed is far more narrowly focused, perhaps even suppressed, by everything from available opportunities to real or imagined fears of adverse formal and informal consequences. This is what lays out the spectrum of human behaviors as each person lives and dies in a world of those who are more capable of predation than trustworthiness against those who are more prone to be the counterpoint to and prey of the greedy.
A recognizable, legally definable entity is called a "person." A person can be an actual human being, but it can also be something larger, like a married couple acting through the contract of marriage or like a partnership or corporation acting through the contract of its recognized organizational enterprise. In the case of the marriage, the "couple" is a person, significantly bound by and recognized through the state-sanctioned, standardized, legally enforceable contract of marriage. A partnership is a person by virtue of the expressed or implied, legally enforceable contract that constructs the interactive, joint relationship of action in the enterprise to which the partners are mutually bound. A corporation is a person by virtue of its state-recognized, qualified, so-called "articles of incorporation," which set forth the particulars of matters that include, among many, the divisibility of the entity's capital stock among its current and possible owners and the physical place of nominal business activity. A government is a person, too, by virtue of its sovereign right to act as a single, unified, comprehensive body with respect to the governance of its citizens and other residents, its right and capacity to make treaties with other, similar sovereign entities, its ability to specify and enforce terms of internal and external commerce, and its putative right and nominal ability to interact with expressed defensive or aggressive intent and result against other, similar entities.
A "principal" is a personspecifically in economics, one that is acting to the end of maximizing self-interest. An "agent" is a person who is charged by formal or informal contractual agreement with carrying out such duties as will promote the maximization of a principal's self-interest.
Percy is Ned's agent with respect to the enterprise of Ice Kreem Kween. Because Ned incorporated the business under relevant provisions of general corporation law of the state, Ice Kreem Kween is a person in its own right, and Ned is its owner. The employees of Ice Kreem Kween are contractually bound to do their best in their productive employment by the company to advance the interest of Ice Kreem Kween. In other words, the employees are duty-bound to do whatever they must, given the business and legal environment constraining their actions, to ensure that Ice Kreem Kween is as profitable as possible.
Agents and principals operate within the context of a contractual relationship. Such contractual agreementsand even some agreements that don't meet all the criteria of 'contract'can be expressed or implied; they can be written or oral; and they can be "bilateral" or "unilateral." The 'expressed or implied' simply means that the parties to them can explicitly declare that there's an agreement, or they can simply understand, without saying or writing as much, that there's an agreement. The 'written or oral' means that the parties can write down exactly what their agreement entails for everyone involved, or they can simply say as much. That 'bilateral or unilateral' part means that contracts can place obligations on each side independent of performance by the other, or they can place obligations on one party that are relevant only if the other party performs.
The key, though, in agency relationships is that some kind of agreement exists whereby one party is duty-bound to advance the interests of another group.
Back about a year after Percy started working at the chemical plant, he got called to the corporate offices, which were located in a beautiful five-story building on Sandusky Street. He drove there during his lunch hour and went in to the lobby. He'd never been in the building before, so he was pretty amazed by how fancy everything was. This was back when Batavia was still doing well as a community, but the inside of that corporate office building was darned nice, even by the standards of the snooty people of upstate hicksville. Percy was escorted by a nice young man to an elevator and taken to the fifth floor, where he was introduced to a secretary sitting at a desk near a set of huge, polished wood doors. The lady called someone on her phone, and then said, "Mr. Proctor will see you right away."
Mr. Proctor was one of the vice presidents of the company. At least that's what Percy had heard. The doors were opened, and the secretary took Percy down a long, wide hallway, past doors to offices and open areas, and finally to a set of doors near the end. Sure enough, the name plate on the door read: 'John Proctor, Vice President, Human Resources.' The secretary knocked on the door and then took Percy in. Mr. Proctor got up from his chair, which was behind the biggest, most impressive desk Percy had ever seen, and reached out to shake Percy's hand.
Percy was sure he was going to get sacked, but he couldn't figure out why such a fuss was being made to do it. Mr. Proctor asked him, "Percy, how much do you know about Hockman Industries?"
Percy was shaking in his boots as he sat down in a nice chair in front of the desk, but he didn't let on. "Well, sir, I guess that's the company that owns the plant."
"You're right, Percy," Mr. Proctor smiled. "This chemical factorywhat we all call the 'Delta III Facility'is one part of a subsidiary of Hockman Industries, Inc. We're part of a public corporation: our owners are tens of thousands of shareholders all over this great country. Those stockholders have chosen to invest their hard-earned money in what we do for a living. Wethat means you, me, and everybody else who works herework for those shareholders, so we all have to do what's right by them, even when it might not be right by our co-workers, our friends, or even sometimes those we love and care about. Now, we surely don't want to ever be in a situation where it comes down to our jobs or our families, and I think we've done pretty good by our employees."
Percy couldn't argue too much with that. He was making more money than he ever had beforenine-fifty an hourand Mr. Proctor was pretty much right that a fellow should do what's best for the people who own the place where he works, so Percy summed it all up by saying, "Yes, sir, I agree."
"Good," Mr. Proctor smiled. "Listen, Percy, I need you to tell me the honest-to-God's truth here today. We've been hearing rumors that someone's trying to start up a union down at the plant. Do you know anything about this?"
Percy felt a little sick inside. Joel was the one doing the union organizing: he's been working with some people out of Rochester who'd given him literature to pass out. In fact, one of the pamphlets Joel was distributing the week before was right there on that gigantic desk of Mr. Proctor's. "Yes, sir, I've heard the talk, but about all I know is that the literature is just showing up in the break area." Percy figured he'd live through this with some lies, then he'd get Joel over to his place that night and kick his butt for getting people in trouble with the union stuff.
"So you're saying you don't know who's doing this, then," Mr. Proctor pressed.
"I'm not saying I don't know anything," Percy answered. "Everybody knows there's a few trouble-makers, and everybody I talk to figures it's gotta be the same people... probably the same ones who never get a lick of work done and never show up for work on time." Percy was going to do his best to lead the vice president off the trail and give him something to try to figure out for himself. "I understand everything you said about the shareholders and how we all have to do what's best for them, but I don't want to be the one who rats on people who could cause me and my mom grief, especially since I haven't seen anything myself, and everybody I know is pointing fingers at everybody else."
Mr. Proctor was looking a little puzzled. "What do you mean, 'pointing fingers'? Are the people at the factory not wanting a union?"
Now, Percy could get back to the plain truth. "Everybody figures that you'll shut the plant down the minute a union comes in out there. We'll all be out of jobs, 'cause you'll take the whole operation and move it to some Third World country." Percy straightened himself in his seat. "Even if some union tries to come in here, sir, no one's going to vote for it. You'll just can every last one of us. It's like you said: you have to do what's right by the shareholders; and paying us big money and giving us things like medical benefits is money out of the pockets of the owners... just like that great big giant desk you're sitting behind and just like that Lear Jet you guys fly in and out of the airport every day and just like this whole office with fancy oak doors and carpets better than anything my mother will ever have in the home she dearly loves and pays for with her own money."
Percy was expecting to hear Mr. Proctor fire him right there and then; but instead, he just laughed. "I'll give you credit for speaking your mind, Mr. Luntz. You've got it all wrong, of course, but it's not your job to get things at the corporate level right. I can always rely on Bill Teller to tell me what's really going on down there."
Bill Teller was the day shift line manager in Percy's division, and Percy couldn't resist the opening: "Yeah, I always knew Bill was good for something besides ordering everyone else to do his work for him."
The bluntness caught Mr. Proctor off his guard. He didn't have anything to say about that; he just shifted his upper body back and forth in his big, high-back leather office chair.
Percy smiled and continued, "I'm just speaking my mind, sir. The shareholders of this corporation might have a lease on my body for eight hours a day, and I'll bust my butt to do right by them; but I won't stop thinking about how things really are."
Mr. Proctor pressed the phone by his desk and picked it up to tell the secretary to come in and escort Percy back to the parking lot. He then stood up and put his hand out again for a handshake. "Maybe we'll talk again at some point, Percy."
Percy stood up and accepted the handshake. "Only next time, sir, let's meet down at Berle's Diner. You look like you could use a real meal with some roast beef, mashed potatoes and gravy. I'll buy."
Mr. Proctor, perhaps for one of the few times in his life working for Hockman Industries, broke into a solid, honest grin from ear to ear.
As Percy was walking through the parking lot back to his car, he mumbled to himself, "Damn."
Percy did, by the way, kick Joel's ass that evening, and Joel took the not-so-subtle hint and dropped the whole union organizing effort right then and there.
The above story from Percy's life illustrates a fundamental problem in agency relationships, one that will be formally set forth below. But before the getting to the explicit description of that problem, it's important to point out that agents always have some greater or lesser willingness and ability to extract costs from their principals, costs the principals do not really want to pay and will try to minimize to the extent that they can. These agency costs can be broken into four broad categories.
The first type of agency cost is the perquisite, or "perk": this is a non-contractual benefit extracted by an agent to the detriment of the principal. In the story about Percy's meeting with the vice president of the company, that entire executive office suite was a perk. Those executives did not need that fine office building, those giant wood doors, or the enormous desks to do their jobs, despite their likely insistence that they most certainly did need such things. Neither did they need that Lear Jet Percy mentioned that everyone saw coming and going all the time from the local airport. Not one of those things was a necessary part of doing the work of managing the company, and the cost of those things the executives bought for themselves came directly out of retained earnings that would otherwise have been available to the shareholders. Executive perks are a large agency cost, but executives are by and large entirely clueless that it's not a matter of not "over-spending" on such things; it's a matter of not spending at all on them.
Percy knew very well that Greyhound goes to just about any city those executives would need to get to; and Motel 6 is every bit as good asand a whole lot cheaper thanthe fancy Hiltons those guys planted themselves in when they were on the road. And all the fancy restaurants with the fancy meals at the fancy prices were perks, too: McDonald's might be hard on the delicate stomach of a well-bred executive, but Bob Evans restaurants are just about everywhere, and they're a whole lot cheaper than some French place with a name like Chateau Neuf de Derriere, or wherever it is fancy executives think they have to dine to be as good as all the other executives of all the other corporations similarly sucking the costs of perquisites out of the shareholders' pockets.
The second type of agency cost is shirking: the deliberate avoidance of duties. This can take two forms. In the story above, Percy alluded to a line manager at the plant who was always finding someone else to do his work for him. That's pretty common from the executive ranks clear down to the lowest levels. Sometimes, it's managers like that guy, Bill Teller, who are forever "delegating" their own work to their subordinates. On the other hand, often it's just co-workers who don't carry their fair share of the workload, leaving other people to handle things.
Percy would later come to be even more familiar with shirking, especially the second type, the kind where people just don't do what they're paid to do. At Ice Kreem Kween, many of the high school kids who worked there would show up for work late, drag their feet during the customer rushes, and leave early. Sometimes, they'd come to work stoned. In all of these cases, Percy was carrying the burden, to the extent that he could, of the shirking by others. But he couldn't cover everything, and sometimes customers would leave because they had been waiting too long in line. This affected Ned's bottom line. Moreover, Ned was paying these people to work, assuming that they would show up on time, be sober, and work hard; but they weren't doing that, so Ned was paying them more than what they were worth.
The third type of agency cost is incompetence: the actual inability to do the job. When Percy was in high school, his business math teacher told the students about something called the "Peter Principle," named after some management guru named Dr. Peter, who asserted that every worker rises to his or her level of incompetence. Percy thought this was a pretty interesting insight. The idea is that people who do well at one level of employment tend to get promoted or otherwise find employment that better challenges their skills and abilities; and they'll keep rising in position and responsibilities until they get to the point where they're in a position where they just aren't any good, and that's the level at which they will stop in their career growth paths. The more Percy worked in the real world, the more he came to appreciate just how many managers with authority over him had reached or were near their own personal levels of incompetence.
The fourth agency cost is direct theft. Agents have incentive to steal from their principals. Sometimes, it's minor stuff: paper and paperclips, pens and pencils, and other little things. Sometimes, it's much more. Percy knew very well that one or two kids were sneaking the big buckets of ice cream out the back door and loading them into their cars before they left work, but Percy couldn't be in two places at once, what with the slam from customers right at shift change some days. He thought about putting in a camera system in the back room with a monitor out in the front service area, but he found out that a decent system was going to cost about a grand up front, with tapes, maintenance, and other equipment and services running a couple hundred every month. Percy realized that the cost of what the kids were stealing was actually less than the cost of that extra layer of security, so he dropped the idea.
Percy had hit upon a crucial point about controlling the extraction of agency costs: when the extra cost of monitoring and enforcing compliance is more than the savings that will result, there's no point in doing the extra monitoring and enforcement. In economics terms, "extra" costs and savings (or revenues) are called "marginal" costs and benefits, and it is these marginal costs and benefitsnot the average or the total costs and benefitsthat drive decision-making. Percy correctly decided against an expensive security system because the savings in reduction of direct theft of the principal's property was going to be less than the cost of the additional (marginal) cost of implementing, using, and maintaining the system.
The Agency Dilemma
The problematic aspect of agency relationships can be summarized in the so-called "Agency Dilemma," which can be stated as such:
An agent has incentive to maximize his own self-interest rather than that of the principal to the extent possible under the monitoring and enforcement provisions of the agreement he has with the principal.In other words, if someone is supposed to do work for the benefit of another person, he has incentive to benefit himself, instead, to the extent possible, given the level of monitoring and enforcement he perceives.
A good example of this is Percy's friend, Bruggie, who's had a lead foot his whole adult life when it comes to driving. Bruggie bragged for years about the time he was driving like a blind trout down the county line road. He claims he was going 115 miles per hour when, way up ahead, he saw a county deputy sheriff's patrol car parked off the road on a spur going into Mr. Jackson's bean field. Bruggie says he climbed on the brakes and nearly went into a skid as he approached the waiting police vehicle, sure as anything that whoever was in the car had already clocked him. As it turned out, the deputy was Dale Corgan, who had been on the varsity football team his senior year and who went on to work for the sheriff because he had permanently torn up his knee in the second-to-last game of the season, so he couldn't get a football scholarship, so he couldn't go to college because he was basically as dumb as a rock. Anyway, there was Dale, and he wasn't in the patrol car. He was beside it, bent over, fixing a rear flat on the driver's side. Bruggie figured that Dale had backed into that spur to do some speed trapping and after awhile noticed that he'd punctured his tire on something in the spur. So there was Dale, out there changing a flat; and there was Bruggie, suddenly realizing that he could put the hammer down on the gas as he passed Dale, who didn't look like he gave a darned about anything other than how much he was sweating as he was changing that tire.
Bruggie's story is a great illustration of the importance of both monitoring and enforcement. Even if a behavior can be monitored, it doesn't matter if enforcement can't be carried out; and even if enforcement can be carried out, it doesn't matter if the monitoring is lax.
Life is just full of agent/principal relationships. A parent is the agent of a child because the parent has a duty to maximize the welfare of the child. The child is the principal in that relationship.
The employees of a company are the agents of the owners because the employees are charged with maximizing the return on investment of the owners.
The executive officers of a corporation are the agents of the shareholders because it is the dutyactually, it’s the fiduciary dutyof those officers to maximize the wealth of the shareholders. In this case, it is very important to notice that the executive officers are most decidedly not the agents of the employees, the community, the environment, Mother Earth, or anything other than the shareholders: it is those shareholders for whom they are working and who can ultimately hold them responsible for their actions. It is the shareholders who ultimately have the right (at least, theoretically) to reward them or dismiss them.
A governmentat least in some modern political modelsis the agent of the citizenry since the government is vested with the responsibility of maximizing the well-being of the people it governs. This model, by the way, is not universally accepted: historically, many sovereign states have operated under the assumption that the government was the agent of a god or a group of gods. Some carried it so far as to represent the head of the state as being a living god, thus making the entire population, and all of the parts of the government, agents of this human god-ruler.
The term "fiduciary duty" was introduced above. Fiduciary relationships are special: they are agent/principal relationships characterized by trust, loyalty, and fidelity, which form three pillars upon which the agent must act with respect to carrying out his responsibilities to the principal. Black’s Law Dictionary describes fiduciary duty as being "...the highest duty implied by law." This does not, however, mean that fiduciary duty is purely legal. Despite many attempts by various levels of government to codify its meaning and enforcement, fiduciary duty transcends law and reaches to the very nature of certain kinds of relationships and the cultural understanding of what they entail.
Examples of fiduciary relationships are those between a parent and a child, the executive officers of a corporation and the shareholders, (presumably) a person and his or her god, and a husband and wife (who might be characterized as both being agents of the unified entity sometimes described as the "married couple").
Not all agency relationships are fiduciary in nature, just as not all relationships are necessarily agency relationships, although agency features do have a way of creeping in. The key feature that makes duty fiduciary is an inabilitytemporary, recurrent, or persistent as the case might beof the principal to effectively both monitor and enforce the covenants of the agency relationship. In the example of the child and the parent, a child is physically, emotionally, and intellectually at severe impairment in understanding what the parent should and should not do, and the child's recourse in the event that the parent fails in duty is wholly dependent upon outside resources that might or might not come to bear to rectify failures.
When a surgeon is operating on a patient, the person under the knife is literally incapable of being able to monitor what's going on; and even if he could, his knowledge of medicine, anatomy, surgical procedures, and proper practices is generally so limited as to materially impair any possible hope he could have of assessing what was going on.
In modern corporate organizational theory and law, the shareholders of a corporation are supposed to be separated from the management of the company: that's why the corporation is allowed to exist under every state's general corporation law as an entity separate from its owners, responsible as it then is for its own liabilities, which may not impact upon the owners under any normal circumstances to any extent greater than their respective investments. In practice, that means the shareholders must legally rely upon the officers and directors of the corporation to ensure that shareholder interests are always first and foremost, within the bounds of law.
An American soldier swears oath to defend the Constitution, but the Constitution is nothing more than a piece of paper unless animated by those sworn to preserve it, those sworn to protect it, and those sworn to abide by it.
In each of the examples above, the principal is by nature or circumstance impaired in ability to monitor and enforce the responsible actions of an agent; in each of the examples above, therefore, the agent has imposed upon him, it, or them a "highest duty" under law, custom, and tradition, a duty shaped not by the normal incentive to maximize self-interest, but rather by the invocation of inspiration from trust, loyalty, and fidelity.
Life as Agency
Ned never did tell Percy, "You're the boss around here," although he came pretty close. Nevertheless, Percy knew he had become something more than just another employee: for one thing, he had to be there most days from opening to closing, and he'd even started doing most of the hiring and firing.
Percy had grown up to be a good man and a good employee; and even though he never did get to go to college and take business courses, he had a good mind for how to run the Ice Kreem Kween, and he didn't need to hear about fiduciary duty to understand that his relationship with Ned was based upon more than just Ned's willingness and ability to keep an eye on him. Percy by his nature knew when it was time to do what was right by Ned because of trust, loyalty, and faithfulness.
That left only one thing for Percy to worry about: he realized that he had risen as far as he could at Ice Kreem Kween, so if he stayed there for the rest of his life, it would probably mean that he'd made himself a textbook example of that Peter Principle his high school teacher had talked about.
That's why Percy always checked the Sunday paper to see if there was any better job in town he could apply for.
The Dark Wraith has thus offered a long and useful economics lesson.