What is the difference between a principle agent problem and moral hazard?

Principal-agent problems and moral hazards are related in that one gives rise to the other. Principal-agent problems occur when the principal of an entity hires on a company or individual employee to complete designated tasks that tend to solely benefit the principal and compete with the best interests of the company or employee who is asked to complete the tasks.

When this type of situation arises, moral hazards occur. A moral hazard typically involves information that has been issued by a company when entering into a contract with another company, or an agent being deliberately skewed or altered to attempt to make a profit on a contract. An onerous contract is an accounting term for a contract that will cost a company more to fulfill than the company will receive in return. The agent involved will find themselves in a situation where they are forced to abide by unfavorable contract terms for fear of losing out on the business deal. The agent may have also been offered incentives too tempting to refuse, leading them to make a decision that is costly to them while benefiting the principal.

A moral hazard can arise anytime an agreement is entered into between two entities. Although an agreement has been reached, either party may decide to act in a way that skews the agreement. A clear example of a moral hazard occurs in the case of a salesperson who is compensated at an hourly rate with no commission. The salesperson in this situation may be inclined to put less effort into their performance, as the rate of pay doesn't change regardless of how hard they work. Typically this sort of situation can be avoided by altering the pay structure to include both an hourly salary and commission to serve as a performance incentive. This proves favorable to both company and employee in this scenario.

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