Behavioral Agency Problems and Solutions: A Research Agenda for Organizational Law and Beyond

Legal scholars examine questions across the law through the economic principal-agent lens. In economic parlance, an agency relationship exists when the welfare of one person, the principal, depends on the actions of another, the agent. In such relationships, an agency problem arises as principal and agent interests diverge. As agency problems cause inefficient outcomes for the parties, principals and agents attempt to ameliorate them, through ex-ante incentive contracting, monitoring the agent’s performance, and more. Such solutions are often costly and limited, however, so that agency problems generate agency costs. From the agency perspective, therefore, an important function of the law is to reduce agency costs and thereby facilitate more efficient principal-agent arrangements. Yet the legal literature that analyzes organizational law and related fields through a principal-agent lens is almost universally based on the unrealistic assumption that the parties are perfectly rational actors, an assumption that runs contrary to an extensive body of empirical evidence on human behavior more generally and organizational behavior in particular. To begin remedying this discrepancy, this chapter explains how the behavioral processes that lead real-world principals and agents to deviate from rational agency model predictions produce two distinct sets of consequences: First, behavioral agency problems sometimes arise where traditional analyses anticipate none (or exacerbate recognized agency problems). Second, behavioral forces may solve or ameliorate some agency problems, diminishing their costs in ways that traditional models typically fail to account for; these two sets of effects have far-reaching implications for the myriad real-world situations that give rise to principal-agent relationships and, in turn, for the various legal rules and institutions that address these relationships in organizational law and beyond.