Recently, on the news there was a story about how a local city found itself in q
ID: 1119629 • Letter: R
Question
Recently, on the news there was a story about how a local city found itself in quite a financial bind due to the contracts the mayor had signed with the employees union. The contracts were so generous that it left the city with very little money for other things, like parks and festivals. Unfortunately, this type of agency problem is not unique. We see similar problems when school boards agree to contracts with teachers unions. However, we shouldn't think of these outcomes as specific to government officials and public employees' unions. We can see it in our own class. Throughout the course, you were asked to evaluate your team members' performances. While there were a couple of people who rated others critically, most rated everyone either at a perfect score of "10" or close to it.
One of the keys to effective management (and economics) is to recognize incentives. In no more than a one page answer, please explain two things. First, explain how both situations (the city and the class) described above are agency problems. (Be sure to identify who is (are) the principal(s) and who is (are) the agent(s).) And second, how can the incentives be changed to get better results for both the listed contracts and for this class?
Explanation / Answer
The principal is the person for whom the assessment is required. In the city case, the residents of the city are the principals. In the colleg case, the instructor is the principal. The agents are the persons executing the requirements of the principals.So the mayor and the students are the agents in the two cases.
Incentives can be improved by putting in place adequate mechanism so that agents do not try to hide or distort information. In the case of listed contracts for example, the mayor could be made responsible personally as well for falling short on fulfilling budget commitments. A portion of her compensation could be clawed back in such a scenario. Though this is a radical solution and is not followed in any democracy.
In the classroom case, the principal should award the assessors, if their assessment is close to what the instructor herself has awarded to the respective assessees. In this case, people's own performance wwill become tied up to how accurately they judge others.
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