How to Solve the Principal-Agent Problem

The Principal-Agent Problem can make or break an organization. As the leader, you must understand the roles and expectations of both the principal and the agent, and provide the thread that ties them together.

To Reach the Pinnacle of Success…

“I need you all to understand, business this summer is going to shrink drastically. You won’t be getting as many hours as you’ve been used to. I have to keep costs down to keep us profitable. But things will return to normal once the university opens back up in August.”

This was my first attempt to deliver the difficult news to my kitchen staff. They didn’t take it well. As the general manager of the restaurant, as the leader they all looked to for guidance, I blew it.

My problem was that I didn’t understand both sides of the Principal-Agent Problem. There was no thread that linked my perspective to theirs. To put it simply, the principal (the leader) has the incentives to do what is best for the good of the organization. The agent (in this case, the employee) often only has incentives to do what is best for themselves. Most agents just don’t care enough about what the principal cares about—different incentives, different goals.

For a team to ever reach the pinnacle of success, both sides must understand each other.

Something Has to Give

I’ve written two short essays that have touched on the Principal-Agent Problem, here and here. Both were written for the agent to understand the principal’s perspective. But as a leader, it’s equally (if not more) critical for you to understand the perspective of the agent as well.

Because my restaurant was still in its first year of existence, and because it was located right on the edge of a large university campus, our business was inherently linked to the academic calendar. Every dollar that came in over the initial six months would be heavily dependent on campus activity: sporting events, graduations, homecoming, and parent visits. During the summer months, the campus became a ghost town. But my kitchen staff didn’t understand that. They didn’t care. They just wanted their 40 hours each week, to do their jobs, and to live their lives like they had at other normal restaurants. I couldn’t blame them. Who doesn’t want a steady paycheck and stability?

As a relatively inexperienced restaurant manager, I had a difficult task ahead of me. There was no option to keep every member of the kitchen on the schedule full-time—labor cost restraints wouldn’t allow it. But I also didn’t want to lose any of our excellent cooks. They either had to accept a drastic reduction in hours (and in pay) or leave to find another full-time gig. Something had to give.

Like Landing without a Parachute

The way I initially broke the news to them was like jumping out of a plane and landing without a parachute. They all knew what was coming during the summer months. I’d been subtly warning them for weeks prior to the university’s graduation week. But they didn’t take it seriously until I made it a point to speak to them all directly. When I did, they reacted with a range of negative emotions. The trust and the relationships I had built with each of them didn’t matter.

When survival takes hold in the mind, none of that matters.

To truly motivate yourself or someone else to do something, you have to start with knowing the “why” behind it. Of course, both sides in my story understood the why behind what we were trying to do. I needed the restaurant to survive. The kitchen staff… simply needed to survive.

Framing the Message

What I failed to do was frame the news from their perspective. I failed to link my why to their why. I never provided a thread to keep both sides together. I mistakenly assumed that because everything made sense to me, everything would make sense to them. But when it comes to someone’s livelihood, as the principal, it is critical to speak with the agent, not to the agent.

Instead of my initial statement (at the start of this article), I could have reframed my message like so:

“We had an amazing first few months as a restaurant. We broke records that none of our other locations had ever even come close to. We’ve received glowing reviews of the food. News outlets and government officials come here specifically for your food. None of this would be possible without you. You are the heart and soul of our restaurant. We face a challenge over these next few months, as business will be slowing down considerably. It won’t be easy, but we’ll have more time off, we’ll have more vacation time, and we’ll have more time to spend with our families. If money is an issue, please come to me and I can help you find additional hours at our other locations. No matter what, remember, we’re in this together.”

Notice a few key differences:

1. I emphasized the excellent work they’ve done. I let them know how vital they were to our success. A sense of meaning can go a long way.
2. There was no “I.” There was only “you,” “our,” and “we.” I highlighted the fact that we are all together in this, and that I am faced with the challenge along with them.
3. I spoke to their love of family. I knew they were all deeply family-oriented, and that even if they didn’t have the number of hours they were used to, those hours would serve a purpose more meaningful to them.
4. I offered them a practical solution: finding additional hours at other restaurant locations. This would keep them from feeling hopeless during the long summer months.

Although the staff had to deal with the same difficult news either way, they were able to understand because I framed it from their perspective, not the business’. Since I had blown my opportunity at the group meeting, I took the time to sit with each of them individually to deliver the revised and reframed version. This was my way of providing that parachute for a hard landing. And because I was able to momentarily solve the Principal-Agent Problem—to see things from their perspective, we were able to keep the vast majority of the team together through the summer.

To solve the principal-agent problem, reframe your message, make sacrifices, and provide a common thread of understanding. Your efforts will be noticed, and you will cultivate a deeper trust and respect.