In applying the principal-agent theory to microfinance management, the top management
is identified as the “principal” and loan officers (and other field staff) as the “agents.”
The framework then focuses on difficulties that managers have in working with staff
members to whom daily decisions have been delegated. The bargaining power of field
staff is strengthened here since some of their efforts cannot be fully observed. Managers
must then figure out how to adequately reward their unobserved effort in order to most
effectively maximize the institution’s objectives.
The concern with agents that can take unobservable actions that may not be entirely
aligned with the interest of the principal goes back to Mirrlees (1974, 1976) who
provided a framework that has been applied to a large variety of contractual relationships,
including those between employers and employees, managing Microfinance insurance
companies and insured individuals, and politicians and bureaucrats (and to the moral
hazard problem between lenders and borrowers). The framework describes the best
possible contracts that principals can design to elicit maximum (unobservable) effort by
agents. The contracts have to take into account that the agent may have outside options
that have to be at least matched in order for the agent to voluntarily enter into a contract
with the principal. A tough contract with harsh penalties for poor performance (a onemilliondollar
fine?) may get agents to take the desired action, but in practice it would be
hard to get anyone to agree to the terms. This is often called a “participation constraint” or “individual rationality constraint.”
Kavungya answered the question on March 26, 2019 at 10:42
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