Question

Claudia owns Ella Marie's Cafe. She went on vacation last week and left the running of her cafe to her employee, Jake. When she returned from vacation, she found out that Jake had closed Ella Marie's early every day so that he could go fishing. This is an example of _____.

a) an adverse selection problem

b) a principal agent problem

c) a financial market problem

d) the lemon's problem

Answer 1

The right answer is option B, that is, a principal agent problem. Principal agent problem implies that one party involved in the risky activities because they are aware that they do not have to bear the cost of those risky activities, it is the principal who will bear the cost of these risky activities. In this case, Claudia will bear the cost of closing the cafe early every day and Jake knows that it does not effect his salary because his salary is fixed and does not depend on the profits of the cafe.