Principal Agent Problem in Entrpreneurship

Why accountability is a single player game?

In my previous article on accountability, I defined accountability as the ability to take risks and accept failure in public under ones own name. The 3 pillars of accountability we defined are risk, ownership and public commitment. Lets dive deeper into accountability & look at why it is important from wealth creation perspective.

Ray Dalio, the founder of one of the world’s largest and most successful hedge fund Bridgewater associates, crystallized his learnings in life in a book named ‘Principles’. Its a terrific book that I highly recommend to all my viewers. Ray has described that every man’s life can be explained by a simple illustration he calls as the ‘circle of success’

Every person picks a path in which (s)he wants to grow. This path eventually leads to setbacks that make her fail. These roadblocks compel a person to try out different ideas/methods to sustain the growth. While most iterations might not yield results, a few will lead to improvement. And this improvement drives further growth. 

So your entire life on paper is just the number of circles you have completed. Greater the number of circles, more is the quality and impact of life.

If we look at the stages of this ‘circle of success’ closely, we’ll understand the role of accountability. Lets start with the first step of growth – when we start on anything, we usually expect the path of growth to move like below.

Unfortunately, nothing worthwhile in life follows this path – Mother nature ensures that the forces of life bend this path and reverse its course. Degree to which the path deviates can vary from the situation to situation but deviation is inevitable.

 Once you enter stage 2, bad things start to pile up on each other and the deviation starts getting steeper and steeper . Most probable outcome of stage 2 is that it overwhelms us with stress and adversity and the path ends in a failure.

A failure doesn’t close the loop of ‘circle of success’ and doesn’t lead us into the the next circle – failure that way is a permanent end to a world of possibilities created by successive circles of success.

A person who takes ‘risks’ fights failure with ‘iterations’ – since she feels the pain of loss, she fights back by looking at the universe of alternatives to change the course of current path. So accountability bends the curve and prevents our descent into the permanent path of failure.

Once iteration kicks in, there is a risk of spending too much time experimenting. Losing a lot of time on iterations leads to missed opportunities.

Here again, accountability helps in bending the curve upwards – your public commitment compels you to seek out alternatives that lead to significant improvement and ruthlessly reject alternatives that don’t work. 

Once you start seeing growth, there is a tendency to settle down and be content with that growth. This means that you aren’t opening the doors to enter the next circle of success that builds on the growth from the existing circle of success. Missing out on successive circles leads to stagnation and stunted growth.

Accountability helps again to pull back this curve and pushing it into the next circle – your ownership makes you obligated to complete this loop and enter the next.

Notice that apart from the first deviation that was largely controlled by mother nature, at every other deviation, it is accountability that did the necessary course correction to our ‘circles of success’. People without enough skin the the game can’t access this internal compass called ‘accountability’ – lacking this tool makes them miss out on a ‘feedback loop’ to figure whether they are on the right path. 

Accountability is our life’s compass and is the only tool available to us for course correction.

Biggest takeaway I have is, never do things in life where you don’t have absolute skin in the game. This takes us to the next topic – is accountability shared? Can I hold my team accountable? 

Whenever you see a person who claims that his/her team is accountable – you know the person hasn’t understood what accountability really is. Accountability of a group is like utopia – feels great to write down on paper but doesn’t exist practically. This is one of my biggest learnings for me as an entrepreneur.

Whenever a group or team comes together with shared objectives, it is inevitable that each person carries a different risk/reward profile. There are people with high incentives, high risk, people with high incentives, low risk and people with low incentives, high risks. You will rarely find scenarios where people have low incentives, high risks – it is difficult to sustain this mismatch in risk-reward profile.

Each person is continuously taking decisions that maximize his/her reward and minimize risk. When accountability is assigned to a group, it simply collapses when tasks move from people with high risk/high reward to low risk/low reward. Tasks get clogged, pressure builds up and finally the whole thing collapses – its like a pipe burst that happens when water comes in a high pressure and pipe is simply not designed for those pressures.

Let’s take the case of a founder – Now let’s look at the risk pie – the red circle shown below is your entire risk as a founder.

Employees share a lower risk compared to their incentive – Assuming a highly competitive labor market, there will always be an employer who can match the existing pay grade for a skilled employee. This supply creates a lower risk to employees. Vendors share a higher risk proportionate to their rewards – vendors not only have a price risk but also run a reputation risk. A failed outcome harms the vendor more because it can lead to potential loss of business from other similar customers. Advisors and consultants carry very little downside – they work on a fixed retainer basis and in the worst case scenario, they tend to lose this retainer. Investors have a fairly large risk overlap with founder but usually the risk sharing is lower than incentive sharing. The residue risk that a founder carries creates what is called the ‘agency cost’.

In this example, founder is the principal and agent is all the other stake holders such as employees, vendors, contractors, advisors. If agent’s risk and incentives are aligned with founder, ie there is maximum overlap on this chart, residue risk is smaller creating a ‘low agency’ environment. If the residual risks are high,  ie there is minimum overlap on this chart, principal’s risks are disproportionately higher than agent’s risks, creating a ‘high agency’ environment. 

This takes us to the last section on ‘how to practice accountability’. ‘Accountability’ is not a skill that needs to be improved, its a tool that needs to be used. Each one of us has that tool, but most of us don’t put it to use.  To use this tool, I can suggest 4 ways

  1. Start your own full-time business. ‘Full time’ is important here – you will not demand accountability out of yourself if you are doing a day-job and devoting spare time to your business.
  2. If you cannot do the above, start a side gig that with a goal to earn 1$ a month for 12 months. When someone gives you a $, he/she expects public commitment from you. Try it – it forces you to practice accountability. Needless to say – no cheating – you can’t get any help from friends and you cant resell your personal items such as shoes, car, guitar etc..
  3. Commit 5 years of your life to something without a Plan B. Regardless of what happens, what you earn, how long you earn, family situation etc, you just keep following Plan A for 5 years. period. Committing to something without Plan B has a huge opportunity costs that forces accountability.
  4. Invest in a project where there is a risk of significant loss of initial capital. You can build an investment portfolio in stocks, invest in your friends/family business. You will be accountable to yourself and demand accountability from others who have received your investments

Apart from these 4, I don’t know any other ways to bring accountability in your life. I would argue that there isn’t any other way.
To summarize, 

  1. Accountability is our life’s compass – a tool for course correction. Without accountability, you miss a feedback loop in your life.
  2. Accountability, unlike responsibility, cannot be shared. 
  3. Teams with loose alignment of risk creates ‘agency costs’. Higher the agency cost, lower is the accountability
  4. We discussed the 4 practical ways to be accountable – pick yours and run with it