Principal Agent Theory and its Application to Analyze Outsourcing of Software Development

Principal Agent Theory and its Application to Analyze Outsourcing of Software Development

ABSTRACT Much has been written on process models, project management or tool support to increase the return on investment in software through higher quality of the development process and the resulting software or system. Yet, we lack understanding in the underlying economic principles; e.g., an external firm paid to develop software for someone else tries to maximize their own profit instead of the contractor’s. These divergences of interests result in projects that consume more time and money and meet fewer requirements than expected. In this paper, we try to fill the gap by providing an insight into the theory and presenting applicable suggestions how to diminish or avoid the problems that arise when selecting the ‘best’ contractor and during the project. Basic advises on the formulation of contracts can be derived.

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Principal Agent Theory and its Application to Analyze Outsourcing of Software Development

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