Principal-Agent Problem
When the person hired to do a job has different interests than the person who hired them.
#Plain-English Definition
The Principal-Agent Problem happens when you (the Principal) hire someone (the Agent) to act in your best interest, but they act in their own best interest instead.
- Example: You hire a real estate agent to sell your house for the highest price. But the agent just wants a quick sale to get their commission fast. They might pressure you to accept a lower offer.
- Politics: Voters (Principals) elect politicians (Agents) to improve the country. But politicians might focus on getting re-elected or helping donors instead.
#How Prediction Markets Solve It
Prediction markets help align incentives by creating Skin in the Game.
If a CEO says "We will double revenue this year," they might be lying to boost the stock price (Principal-Agent problem). But if there is a prediction market on "Will revenue double?", the CEO can't easily fake the market price. If the market says "10% chance," the truth is out.
Concepts like Futarchy propose using prediction markets to fire agents (politicians/CEOs) if they fail to meet the metrics defined by the principals (citizens/shareholders).
#Key Takeaways
- Agents often prioritize themselves over their Principals.
- Prediction markets provide an objective "truth layer" that makes it harder for agents to lie or underperform without being noticed.
- They force accountability through financial incentives.