The Principal-Agent Problem: Why do drug cartels age poorly and what can we learn from them?

It is hard to imagine the life of Jorge Salcedo Cabrera as uneventful but a degree in civil engineering and a stable job indicated no predilection off the straight and the narrow. This was in 1989, before his meteoric rise to the position of head of security for the Cali cartel, which at its peak for about two years in the mid-90s, controlled 80% of the global cocaine market. The man who was entrusted with the specific task of helping bring down Pablo Escobar, the biggest drug lord at the time, would in just a few years be the man responsible for the eventual dissolution of the Cali cartel. In 1995, after Jorge’s information led to the capture of one of the Cali linchpins, he entered the US Federal Witness Protection Program, where he remains to this day.

Why is it so difficult for drug cartels and crime syndicates to continue to stay ahead of the curve? Why are their shelf lives so much shorter than Amazon’s? Why do they age so poorly? Using criminal organizations as an example, I argue here that innovation needs a shared goal, and unity in purpose is hard to foster in an environment where trust is low, leading to misalignment of priorities. I also suggest that bridging this misalignment (the principal-agent problem) is key to business longevity.

The innovation-trust loop

Innovation is built on ideas. The best ideas emerge from a healthy and continuous cascade that is rigorously filtered. This filtration occurs best through a process of constructive conflict where the power of many and diverse perspectives is harnessed. Conflict is productive when participants work toward a collectively advantageous goal. Successful organizations typically manage to create a sustainable environment for constructive conflict where employees trust each other. Trust springs from having agreed on a common goal. Belief in a collectively beneficial goal is thus at the core of any innovation engine.

Drug syndicates face problems in getting this loop running right from the start. Terrible ideas are an inevitable consequence of idea brainstorming, but a poorly conceived plan in a high-stakes environment may result in fatalities. This severity of downside induces self-censorship among participants, who now prefer to keep their mouths shut. Such self-imposed screening doesn’t automatically keep bad ideas away; it makes the ideas of those in positions of power go unchallenged.

A process of judicious filtration of ideas would be possible where there’s a common upside or downside for all participants. Here’s where the crux of the problem is. The concept of a shared goal in criminal gangs remains the hardest to enforce because of a concept most commonly known as the principal-agent problem.

The principal-agent problem

The principal-agent problem is a misalignment between the incentives of the owner or employer (principal) and the employee (agent) authorized to act on the employer’s behalf. In drug syndicates, members may act in their own best interests because the upside to defection is big and failure can be fatal. A member may see cheating his current employer as a means to show loyalty to his new employer and earn a fast-track up the ranks. This jeopardizes the success of his current employer whose objective he is at odds with, and creates an environment of mistrust where all parties are continually looking for signs of dishonesty and actions and words carry exaggerated signaling power.

While the issue of misaligned priorities between owners and employees is perhaps most pressing in illegal businesses, it is hardly restricted to them. Be it in a consultant we hire on an hourly arrangement who expands the scope of the project to clock up more hours, or in our own choice to solve a problem multiple times instead of working to prevent it from occurring because the former may look better to our manager, misaligned incentives between the principal and the agent are everywhere. It is the single most common problem across managerial rank.

Solving the principal-agent problem

Criminal organizations do not so much solve the principal-agent problem as they find workarounds by employing specific strategies such as having family run operations, maintaining information asymmetry, and punishing defection disproportionately. Yet, these strategies do not travel well to businesses that do not have employees lose their lives if a project ends poorly. So how can owners (founders, promoters, managers) of legitimate businesses design incentives in a manner that has their teams sing from the same sheet as them?

Align individual incentives with organizational goals: This could be done in a few ways such as setting up an org structure where it is a win-win for teams to share information instead of working in silos, or linking individual payouts to business unit goal achievement. Shared support functions and dotted line reporting are common hurdles to alignment.

Reward principal-like behavior: Actions speak louder than words. Encouraging, identifying, and promoting those with a captain’s mindset to positions of higher accountability is a much clearer signal than simply talking about a culture of meritocracy.

Give them skin in the game: People are more likely to align with the company’s priorities over time if they share both upside and downside of business performance. This could happen through shared ownership so that managers aren’t incentivized to make riskier allocations or employees don’t choose easy projects with low business impact.

“Be generous with your top lieutenants”: This one goes back to Naval Ravikant, investor-philosopher, who suggests that our best people are more likely to reciprocate our faith in them by aligning with us over time, if we’re generous with them in terms of ownership and incentives even if they may not specifically have asked for it.

For those of us not founders, adopting a founder’s mindset is nevertheless helpful as doing so over time means we’ll be noticed by principals and pushed up through the ranks, in addition to learning to build our decision-making muscle without ego.

Conclusion

The central difference between our work lives and those of drug traffickers lies in the attitude toward disagreement. Reid Hoffman, investor and co-founder of LinkedIn, believes that “disagreement is the wellspring of great ideas and great companies — but only if you harness the conflict constructively.” Drug cartels are set up to avoid disagreeable dialog. Our workplaces don’t have to. What we need as knowledge workers is a healthy dose of external examination of our most beloved ideas.

When owners find employees or managers find team members not subjecting their theories to scrutiny, it could be a sign that the parties are not working toward the same goal. It points to a principal-agent problem. Making a principal out of an agent is the highest-leverage task in management.