Why Moral Hazard Limits Accountability: The Case of the Principal-Agent Problem

Although I am an agent on a job, I still act in self-interest. And if that leads to lesser work or carelessness in the eyes of the principal…now I am become the example, of Moral Hazard.

If I am interested in the job, that is because of a cleverly devised incentive scheme that is meant to keep me in such a state. To ask no more questions, or choose to rest. And if somehow, I still manage to keep the principal unsatisfied by my work, I shall deserve a beautiful penalty and all the cost of efforts solely to myself.

The Principal-Agent Problem discusses the clash of objectives between the authority figure and the direct subordinate. Both think in self-interest, and both want to maximize their earnings. Here, if and when the agent is left unmonitored in a certain way, creating leeway for the agent- makes the work done inefficient. Inefficient for the principal as higher yields are now far gone. Or the likely used term…Moral Hazard. But from its definition itself, stems the greatest observation of this essay: Would the self-interested exploitative action of the principal also be called moral hazard? Then the current definition wouldn’t even fit.

1.     Villain Agent

Treating this as an only agent-side problem should surely do some good for that specific perspective? Before the agent would move to make a self-interested decision, the work is supposed to be monitored and under full measures of prevention, the concept calls for an intervention by the principal. Yes, the incentive scheme we talked about. The principal intervenes to do the mechanism design, to make sure the agent is involved in the work to bring the yield back. Of course, it’s the ubiquitous remuneration system. But when the principal has: a) vastly greater bargaining power, b) superior information, c) control over the contract, d) control over monitoring, e) ability to change performance requirements, and f) knowledge that the agent has few alternatives—that is a game that only the principal plays while the agent is completely exploited. For any possible response by the agent, think of this in game theory terms- the agent is factually dominated. Another short-sightedness of this theory is to consider the agent’s wrongdoing under asymmetric information, as the major practical concern. When at the same time the concept moves to quantify profit maximizing for the principal, it blames the agent as the source of all possible inefficiencies. The balance between the normative, i.e. what ought to be, and the positive (facts), i.e. what is, is lost under this relationship. Truly lost…

2.     The Line of Inquiry

If the effectiveness of the incentive scheme, and the efficiency of the work done rests on the unrealistic assumptions of direct monitoring and full information, then how can the concept also not assume that the worker can be in discipline either way?

If it is postulated that the principal shall maximize profits, then the welfare of the agent is directly affected anyway. Then, what if the agent's “unwanted” behaviour is itself a rational response to the incentive structure imposed by the principal?

And then, if the principal designs the mechanism that generates the agent's behaviour, to what extent can the resulting behaviour be attributed solely to the agent's moral failure?

A paradox presents itself: If the principal designs the optimal scheme, where the remuneration and effort are both determined by the principal—inducing the agent to work harder, longer, or more efficiently while retaining a disproportionate share of the resulting surplus. The conventional model can still call this optimal mechanism design. But optimal for whom?

Lastly, Principal-agent theory identifies the agent's hidden action as a threat to accountability, and therefore constructs mechanisms to discipline the agent. But in doing so, how can it treat the principal's self-interested behaviour as the legitimate objective of the relationship?

3.     Arguments into logic

Let’s say that the equivalent of moral hazard for the principal’s exploitative behaviour be vaguely called…corruption.

Then the door to accountability opens upwards. But this also doesn’t mean that the entire concept stands corrected. For certain situations like governance, this actually inverts the conventional dynamics of the concept. Is the elected government the principal, moving the public (agents) in a certain direction? Or is it vice-versa? Voters want efficient public spending and honest representation. Elected officials or federal bureaucrats may instead prioritize expanding their departmental budgets, regulatory power, or catering to special interest groups. And special groups bring the lobbying problem up- the smaller elite group with larger interests get heard over the larger group (common people) who have smaller interests in absolute monetary terms. And so the special groups may be the principal, and the elected government- the agent. Isn’t this now a concerning perspective? Would the agent still be connected with moral hazard here? The same person/institution can therefore be a principal in one relationship and an agent in another.

What this theory lacks is not the classification of good and bad for all the similar situations, but the two-way clarification of moral limits.

4.     The Two Way Street

Although we have taken the case of the principal-agent problem, our emphasis is still on the usage of moral hazard.

Till the time we emphasise on the necessity of interventions, there will always be a problem of identification of the root cause for which the intervention must be taken. Also, of the effectiveness of the implementation of the intervention and the outcomes of the same.

The reader should now know that I am specifically talking about the second person perspective. The second person perspective assumes that the problem is already existing and so it tries to study the same. But with a first person perspective, understanding the root cause may never even need an intervention. For example, in a realistic environment, if the authority seems too authoritarian (constraining), it creates a negative, repulsive emotion that itself works against the incentives of the worker. We now have a cul-de-sac, this is the endogeneity of moral hazard, the outcome of the institutional structure itself.

The issue is not that the principal maximizes their objective; it is that the analytical framework may allow the principal's objective to become the benchmark against which the agent's behaviour is classified as inefficient, without subjecting the principal's objective itself to equivalent scrutiny.

5.     A Palindrome: Education

People before me have talked about this problem before, and similarly argued that principal self-interest can itself produce inefficient monitoring and oversight (Miller & Whitford, 2007). And that traditional theories have neglected opportunism by principals (Wagner, 2019). Still to this day, our mainstream literature consists of, not these valuable contradictions but the same traditional approach this essay questions.

How will I get the work done if I rely overly on an incentive scheme? Willingly becoming a pawn with no purpose, nothing meaningful to contribute, and meant to be controlled throughout.

The intentions of this essay were not to question the perspective, anyone can do that. The intention is to really go back the way we came, the same way where we stopped asking the questions. How am I supposed to do it, if that theory isn’t tested empirically or otherwise? The idea that a few set of equations present is taught wholeheartedly without understanding the possible consequences. If the world is prepared for an incentive scheme, and not self-awareness, there will always be moral hazard. If punishment is all we care about, then prevention will go out of hand. If the balance of normative and positive is blown off, and we keep emphasis on directionless quant, sooner the theory will become impractical.

Now although I am an agent on a job, if I feel the system is constraining, draining, and exploitative — I shall change it, quit it, or break it.

Jk jk…no breaking. That will be Moral Hazard!

References

Menzies, G., Hafalir, I., & Simpson, T. (2026). The efficiency of moral character: Modelling principal–agent relations and caring agents within the fiduciary. Journal of Business Ethics. https://doi.org/10.1007/s10551-026-06380-y

Miller, G. J., & Whitford, A. B. (2007). The principal's moral hazard: Constraints on the use of incentives in hierarchy. Journal of Public Administration Research and Theory, 17(2), 213–233. https://doi.org/10.1093/jopart/mul004

Wagner, D. N. (2019). The opportunistic principal. Journal of Institutional Economics, 15(3), 503–518. https://doi.org/10.1017/S1744137418000297