Since the likelihood of a certain event is an important part of making decisions under uncertainty, replacing probabilities with decision weights will make a model more realistic and would thus lead towards a more optimal outcome. If the other way around, agent X puts more weight esay the low outcome since it uk essay on agency problem more representative,??

ul Accordingly, I will substitute the probabilities in the principal-agent model by the decision weights as specified in equation 3.

The optimal way to do this is thus by increasing gH and decreasing gL in such a way that the total sum of wages is lower than in the original case, since the overall expected utility of the agent is then still equal to the reservation utility.

However, if for example?? We would make the model more realistic from a psychological perspective. Decision Making Under Uncertainty 3. The principal might not change anything in prolem wage scheme in this case. First, the degree to uk essay on agency problem it is similar to other known events and second the degree to which it reflects similar features of the process by which it is generated.

Essay: Agency theory – the Principal-Agent Model – Essay UK Free Essay Database

The first case is when effort is observable, since the principal can then set a wage according to the effort the agent has put in. There are several biases in probability judgment and I will discuss a few.

The second case is when the agent is risk neutral, the principal can then transfer all risk towards the agent by giving himself a set wage. The incentive compatibility condition will change to?? The most optimal choice depends on the optimal risk sharing condition. Prospect Theory introduces a more realistic view of decision making under uncertainty and I uk essay on agency problem change the Principal-Agent model by incorporating some of the findings of this theory.


Perrow observes that uk essay on agency problem some organizational structures human beings are other-regarding and even altruistic. Moreover, the condition of optimal risk sharing ultimately decides what the most optimal wage scheme is and whether this is profitable or unprofitable for the principal. Retained from Gonzalez, R. Our work is high quality, plagiarism-free and delivered on time. To overcome the hidden action problem, the agent will try to bridge the informational asymmetries by installing information systems and by monitoring the agent.

The wage scheme will however raise the expected utility of the principal by such an amount that it will be profitable to pay the agent the risk uk essay on agency problem. It seems that behavioral economists have reasonable arguments why we should incorporate assumptions of social sciences into economics, however not all economists agree with behavioral economists.

Some people might be very sensitive to the Law of Small probabilities and therefore will have a low value for?? The parameter accomplishes this by specifying the slope of the curve and it thereby measures the sensitivity towards changes in probability.

Behavioral economics, however, have found that self-interest is not all of human motivation. The agent and principal do not assign the same weights to the outcomes in their utility function anymore. Behavioral economists have done a lot of research on this theory and found that this theory does not seem to hold in the real world. Camererargues that most of the active resistance to behavioral economics is the fear that the alternatives of psychology to rationality are too fragmented and can therefore not suggest a coherent alternative.


To be more specific, I will substitute the probabilities in the model by decision weights.

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They will therefore assign a different probability to the event than would be rational. The agent and principal now value uk essay on agency problem probability that a certain outcome will occur differently.

Therefore, the probabilities do play a role in the optimal solution. As can be seen, substituting probabilities by decision weights can have many implications into the Principal Agent model, which I will discuss next. For example, when the chance of a uk essay on agency problem outcome is very low for low effort, 0, and for high effort, 0.

For the same reason less gL will cause an increase in v’ gL and u’ L-gL will stay the same.

The main assumptions on which agency theory is build, are widely discussed by behavioral economists. Important is to notice that since people hold different knowledge, different believes and have different manners to assess probabilities no single probability will be interpret the same.