Agency Theory: Principal-Agent Problems

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Corporate Governance > Best Practices > Agency Theory: Principal-Agent Problems

Agency Theory: Principal-Agent Problems
Abiodun
I need to understand the principal-agent problems that arise in organisations. Thanks...
 

 
Principal Agent Problems
Bruno
Agency Theory refers to the delegation of work from one party to another.
The principal delegates work to an agent.
In the case of a corporation, the term of 'principal' corresponds to owners and 'agent' to directors.
Conflicts of interest can arise such as:
- The agent misusing his power for pecuniary or other advantage;
- The agent not taking appropriate risk in pursuance of the principal´s interests due to the dimension of the risk can be different between both;
- Information asymmetry can be another problem due to different levels of information they have.
 

 
Agency Theory: The Principle-agent Problem
Mutasa, Turnaround Manager, Zimbabwe, Member
I agree with Bruno. Adding to the detail, the result of such conflicts will typically be that agents pursue self serving interests, including personal enrichment at the expense of maximizing shareholder wealth.
The diversion of interests between principals and agents is the major problem in Agency Theory.
Eventually there will be a need to align the divergent interests of the principals and agents which in itself will be yet another problem.
 

 
Principal-agent Problems in Agency Theory
Obert Chinhamo, Director, Zimbabwe, Member
Reading more about the agency theory of corporate governance will provide you with the theoretical lens for understanding problems bedevilling the principal-agent set up.
The PRINCIPALS (Shareholders represented by Boards) hire AGENTS (CXOs/Managers) and delegate the running of the business to these agents.
However, note that self-interest is a dominant human motive and Gordon Tullock (1976) was quoted saying that, "The average human being is about 95 percent selfish in the narrow sense of the term."
I agree that pursuing self-interest is the dominant agency problem.
The solution lies in having a principal-agent accountability model in which boards monitor the activities of these agents. If not monitored, they may give themselves ridiculous perks on top of astronomical pay and other luxuries that erodes shareholders’ wealth.
However, not all agents harbour self-interest since there do exist some that serve as genuine stewards who serve the best interests of the principals.
 

 
List of Agency Problems
Jaap de Jonge, Editor, Netherlands
Boot and Cools (2007) mention the following 8 categories of agency problems in the relationship between shareholders and management:
A. The inclination to inefficient management, because substantial cash flows become available periodically, which leads to insufficient discipline in investments and purchases (for example empire building).
B. Perk consumption: the appropriation of dubious fringe benefits and facilities.
C. Under-investing, due to managers being risk-averse: why take risks if this could jeopardize our own position?
D. Taking Excessive risks (risk shifting, gambling) after the firm is already in financial distress.
E. Short-termism, trying to influence the stock markets
F. Self-enrichment by management and/or lacking 2-way relation between compensation and performance.
G. Overconfidence of managers, leading to risky acquisitions
H. Narcissistic behavior, attested by an overly positive self-image and surrounding themselves with 'yes-men'.
Source: Boot, A. and Cools, K. (2007). "Private equity en activistische aandeelhouders: Bestuur onder vuur". Preadviezen voor de Koninklijke Vereniging voor de Staathuiskunde, Amsterdam)
 

 
The Agency Theory and Principal-Agent Problems
K.Narayana Moorthy, HR Consultant, India, Member
The Agency Theory enunciates reactions between the principal and the agent in terms of:
- Goal orientation;
- Obligation & Reciprocity;
- Risk; and
- Self-interest.

It has broad assumptions of problems like:
- Bounded Rationality;
- Opportunism
- Information Asymmetry. Information Available for insiders (Managers) are not the same available for public or outsiders. Asymmetry of information does not allow the Principals to be sure whether the agents are carrying out the duties that they should according to the contract;
- Self Interest / Conflict of Interest

Resolving agency problems: Create monitoring & bonding arrangements as per contract specifications; Limit management discretion through structures like independent Board of Directors and independent board subcommittees.
 

 
Agency Theory: Continuing Conundrum!
Michael Holford, Project Manager, South Africa, Member
Whether from a private of public perspective, relationships between management and principles need serious consideration. The runaway MBA crisis (MBA without ethics) highlighted the need for management and administration correction.
I am not aware of any collective collaboration between the private and public management and administrative elements in solving this conundrum? Are you?
 

     
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