Week 4: Principle agency theory
Article 1: Making agency theory work for supply chain relationships: a
systematic review across four disciplines
1. Some key agency theory concepts
− Buying firm (the principle) and suppliers (the agent)
− Information asymmetry: The agent has private information that the principal would like
to know in order to design an optimal contract
o Efficient vs inefficient agents (e.g, in terms of production costs)
− Information rent: As long as the information remains asymmetric, efficient agents can
profit from their high efficiency, which is unknown by the principal
− Goal incongurence: the objectives of the agent and the principle are misaligned
− Two generic categories of agency problems resulting from asymmetric information and
potential goal incongruence between the parties: adverse selection and moral hazard
− Adverse selection: relates to unknown capabilities of the agent before signing the
contract (i.e., ex ante)
− Moral hazard: relates to hidden action after signing the contract ex post
− Contract: Not a contract in the legal sense, but rather a compensation scheme under
asymmetric information
2. Governance mechanisms
− 14 key governance mechanisms aimed at curbing agency problems which are aggreated
into 4 distinct governance strategies:
o Information transfer strategies: dedicated to decrease the level of private
information (create information asymmetry) between parties
o Goal alignment strategies: dedicated to curb self-interest behaviour through
decreasing goal incongruence
o Integration strategies: aiming to decrease both information asymmetry and goal
incongruence
o Psychological influence strategies: involving social mechanisms mitigating self-
interested behavious
− There is a broad range of governance mechanisms that can mitigate these challenges
, 2.1 Information transfer strategies
Information transfer strategies seek to decrease the opportunity for agency problems to occur
Screening
− The principal offers a menu of contracts from which the agents choose, ideally revealing
their type
− Screening is based on the idea that the principal offers agents (who possess private
information ex ante on their “type” such as production costs), a menu of contracts from
which to choose
− The principal can then screen the agents’ type based on the contract they select
Signaling
− The agent voluntarily reveals private information; often because it is efficient (e.g.,
signal commitment or capabilities)
Selection
− Agreement between the principal and agent to interact in sharing information to
identify the agent type ex ante
Monitoring
− Follow up activities by the principal to ensure the agents acts in its best interest (ex
post)
− Form of monitoring vary from intensive behaviour monitoring such as facility audits to
more arm’lenggth output monitoring through quality check and financial analysis
− Monitoring is typically presented as an activity undertaken by the principal, leading to
agency costs for the principal
− Is seen as a core means to reduce information asymmetry
Article 1: Making agency theory work for supply chain relationships: a
systematic review across four disciplines
1. Some key agency theory concepts
− Buying firm (the principle) and suppliers (the agent)
− Information asymmetry: The agent has private information that the principal would like
to know in order to design an optimal contract
o Efficient vs inefficient agents (e.g, in terms of production costs)
− Information rent: As long as the information remains asymmetric, efficient agents can
profit from their high efficiency, which is unknown by the principal
− Goal incongurence: the objectives of the agent and the principle are misaligned
− Two generic categories of agency problems resulting from asymmetric information and
potential goal incongruence between the parties: adverse selection and moral hazard
− Adverse selection: relates to unknown capabilities of the agent before signing the
contract (i.e., ex ante)
− Moral hazard: relates to hidden action after signing the contract ex post
− Contract: Not a contract in the legal sense, but rather a compensation scheme under
asymmetric information
2. Governance mechanisms
− 14 key governance mechanisms aimed at curbing agency problems which are aggreated
into 4 distinct governance strategies:
o Information transfer strategies: dedicated to decrease the level of private
information (create information asymmetry) between parties
o Goal alignment strategies: dedicated to curb self-interest behaviour through
decreasing goal incongruence
o Integration strategies: aiming to decrease both information asymmetry and goal
incongruence
o Psychological influence strategies: involving social mechanisms mitigating self-
interested behavious
− There is a broad range of governance mechanisms that can mitigate these challenges
, 2.1 Information transfer strategies
Information transfer strategies seek to decrease the opportunity for agency problems to occur
Screening
− The principal offers a menu of contracts from which the agents choose, ideally revealing
their type
− Screening is based on the idea that the principal offers agents (who possess private
information ex ante on their “type” such as production costs), a menu of contracts from
which to choose
− The principal can then screen the agents’ type based on the contract they select
Signaling
− The agent voluntarily reveals private information; often because it is efficient (e.g.,
signal commitment or capabilities)
Selection
− Agreement between the principal and agent to interact in sharing information to
identify the agent type ex ante
Monitoring
− Follow up activities by the principal to ensure the agents acts in its best interest (ex
post)
− Form of monitoring vary from intensive behaviour monitoring such as facility audits to
more arm’lenggth output monitoring through quality check and financial analysis
− Monitoring is typically presented as an activity undertaken by the principal, leading to
agency costs for the principal
− Is seen as a core means to reduce information asymmetry
