Agency problem
The agency problem refers to conflicts of interest that arise between principals (such as shareholders) and agents (such as company executives) when the agents are entrusted to make decisions on behalf of the principals. This can lead to situations where agents prioritize their own interests over those of the principals, potentially resulting in agency costs and reduced overall performance.
6 Key excerpts on "Agency problem"
eBook - ePub- A. Ben-Ner, J. Montias, E. Neuberger(Authors)
- 2013(Publication Date)
- Routledge(Publisher)
...When their objectives diverge, principals may disagree on the contract offered to agents. They may also disagree on the choice of the organization’s structure. Another problem stems from individual incentives for free ridership in the exercise of control over agents. Each principal may expect others to commit resources for control, especially when individual returns are small in comparison to the cost of control. On the other hand, if all principals engage in control, there is likely to be considerable duplication of effort. The principal-agent problem has been typically cast with the agent in the role of the ‘villain’ who shirks and hides his activities from the principal. However, moral hazard and adverse selection problems may also affect the behavior of principals, and may also occur in the relations of agents with other agents and of principals with other principals. While the Agency problem is usually formulated as the choice of the organizational structure that best promotes the interests of the principal, this focus may be unrealistic in situations where agents have sufficient countervailing power to alter the organizational structure set by principals. The conventional formulation of the principal-agent relationship commonly ignores the strategic nature of the interaction between principals and agents. Hence, while the principal-agent relationship is a convenient and very useful vehicle for introducing important ideas regarding behavior in organizations, it describes formally only one slice of organizational realities...
eBook - ePubManagement and Organization Theory
A Jossey-Bass Reader
- Jeffrey A. Miles(Author)
- 2012(Publication Date)
- Jossey-Bass(Publisher)
...If the principal and the agent both seek to maximize their own self-interests in this relationship, then the agent may not always act in the best interests of the principal (Jensen & Meckling, 1976). It is generally impossible for the principal to ensure that the agent will always act in the best interests of the principal. However, there are three main ways to help minimize the Agency problem: (1) board independence (the main role of the board is to monitor the behavior of managers); (2) market for corporate control (mischievous managers are controlled by an active merger and acquisition market); and 3) agent equity ownership (managers share ownership of the company and thus help advance shareholder interests) (Dalton et al., 2007). Unfortunately, each of these methods does not come without costs incurred for the principal (Jensen, 1983). Agency costs come from many sources: recruitment, adverse selection, specifying principal preferences, establishing incentives, moral hazard, stealing, side deals, monitoring and policing, bonding and insurance, and hiring agents to oversee other agents (Shapiro, 2005). Sometimes the costs associated with regulating and controlling agents may not be worth the benefits of improved agent behavior (Mitnick, 1998). The unit of analysis in agency theory is the contract that governs the relationship between the principal and the agent (Eisenhardt, 1989). Research focused on the type of contract has produced the best outcomes for the principal. This research has taken into account that people act rationally within limits, are self-interested, and tend to avoid risk. For example, researchers have examined whether outcome-based contracts are better or worse than contracts based on agent behavior. There are two main branches of agency theory: positivist agency theory, and principal-agent theory (Jensen, 1983)...
eBook - ePubAgency Theory and Executive Pay
The Remuneration Committee's Dilemma
- Alexander Pepper(Author)
- 2018(Publication Date)
- Palgrave Pivot(Publisher)
...Its diagnosis of an economic problem, that costs arise because of the different interests of principals and agents, is entirely sound; it is the proposed solutions to the Agency problem when it comes to public corporations that have been found wanting. By repairing agency theory in its application to public corporations my hope is that better solutions to the Agency problem will be forthcoming. That is the ultimate objective of this short book. The next chapter prepares the ground—it explains the important role played by the agency theory in the standard economic model of the firm and identifies some of the problems with this model. Further Reading A number of the main themes of this book are covered in a collection of essays by the economically-minded philosopher, Joseph Heath, entitled: Morality, Competition, and the Firm, published by Oxford University Press in 2004. References Berle, A., & Means, G. (1932). The Modern Corporation and Private Property. New York: Macmillan. Bosse, D., & Philips, R. (2016). Agency Theory and Bounded Self-Interest. Academy of Management Review, 41 (2), 276–297. Crossref Bratton, W., & Wachter, M. (2010). Tracking Berle’s Footsteps: The Trail of the Modern Corporation’s Last Shapter. Seattle University Law Review, 33 (4), 849–875. Chapman, C., Edmans, A., Gosling, T., Hutton, W., & Mayer, C. (2017). The Purposeful Company Executive Remuneration Report. Retrieved from London: http://biginnovationcentre.com/media/uploads/pdf/TPC_ExecutiveRemunerationReport_26Feb.pdf Frank, R., & Cook, P. (1985). The Winner-Takes-All Society: How More and More Americans Compete for Ever Fewer and Bigger Prizes, Encouraging Economic Waste, Income Inequality, and an Impoverished Cultural Life. New York: Free Press. Jensen, M., & Meckling, W. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3 (4), 305–360. Crossref Kay, J...
eBook - ePub- Lucia Michela Daniele, Rémi Jardat, Jérôme Méric, Francesco Gangi(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
...It is an approach which provides for the existence of a contractual relationship under which a party (principal) instructs another party (agent), who agrees to perform a service on behalf of and in the interest of the former, in exchange for compensation. To undertake the service, it is necessary that the agent have a broad degree of decision-making autonomy (Jensen & Meckling, 1976). In general, this conceptual framework is potentially applicable to all those cases of social interaction in which there is a bilateral relationship between principal and executor within a cooperative effort. Given its configuration, the agency model as applied to the field of business theory and managerialism is distorted by the potential divergence of interests between the manager (agent) and the property (principal), as described by B&M (1932). By identifying the manager’s role as that of acting solely in the owner’s interest, B&M implicitly allow the possibility that such an alignment may not always hold well, because a manager could act in pursuit of personal gain, which might often conflict with that of the property (Berle & Means, 1932). Agency scholars, in obsessing over this dilemma, transform a potential risk into a form of recurrent opportunism inherent in a manager’s human nature, imagining solutions and penalties to contain the conflict of interest between principal and agent. In doing so, agency theorists, in their attempts to clarify what is the ‘black box’ we call a firm, assume that it is a form of legal fiction having an essentially contractual nature. The company is a nexus of contracts (Fama & Jensen, 1983); it is not an individual – so it would be misleading to assume that a company has a social responsibility (Jensen & Meckling, 1976). Managerial actions will tend towards safeguarding personal reputations by making unjustified social investment at the expense of the property (Barnea & Rubin, 2010)...
eBook - ePubPublic Administration & Public Management
The Principal-Agent Perspective
- Jan-Erik Lane(Author)
- 2006(Publication Date)
- Routledge(Publisher)
...The principal–agent approach focuses on one cause of contractual incompleteness, namely the ambiguity surrounding the effort of the agent. Ex ante this ambiguity takes the form of adverse selection, meaning that only the agent knows his/her type, i.e. whether he/she will put up great effort or not, or whether he/she is efficient or not. Ex post the ambiguity takes the form of moral hazard, meaning that the agent disguises or hides the real level of effort or efficiency. When the public principal contracts with agents to get the job done in the public sector, then contractual opacity is general. A theory of public agency must account for how the principal responds to contractual ambiguity, especially in relation to the effort of the agent. The fundamental Agency problem in the public sector The accomplishment of social objectives is only possible through the work of people working for government. Somehow these people – the agents – will be contracted by government, implicitly or explicitly, and given remuneration for their work. In the modern state the remuneration tends to be either a salary or a fee and the output of the agent may be measured in terms of some physical indicator of performance. What is not observable is the effort of the agent, although the situation may be verifiable. The parameters of principal–agent interaction in the public sector thus involve the utility function of the principal linked with the output of the agent minus the wage of the agent as well as the utility function of the agent linked with the remuneration minus the cost of his/her effort. Thus, the principal wants to maximise the value of the output minus the costs involved in paying the agent for his/her work, whereas the agent wishes to maximise his/her salary minus the cost of effort. What are the outcomes of this interaction? One may model the relationship between government and a bureau or public enterprise as principal–agent games...
- Rianne Appel-Meulenbroek, Vitalija Danivska, Rianne Appel-Meulenbroek, Vitalija Danivska(Authors)
- 2021(Publication Date)
- Routledge(Publisher)
...These information asymmetries allow the actors to use the discretionary scope for behaviours that maximize their own benefit. In order to counteract this, the principal intends to influence the agent’s behaviour by suitable incentive agreements or incentive systems. The Agency problems formulated within the principal-agent theory take the form of ‘ hidden characteristics’, ‘hidden action’ and ‘hidden information’ as well as in the most challenging variant of ‘hidden intention’. 1.1 Hidden characteristics The Agency problem of hidden characteristics already exists before the conclusion of the contract (ex-ante) and affects the relationship between principal and agent after signing the contract. The principal cannot observe the performance of the agent ex-ante and, equally, the characteristics inherent in the agent remain unknown to the principal (Ebers & Gotsch, 2006; Picot et al., 1999). Only after the contract has been signed or the service has been performed is the principal able to determine the suitability of the agent. He can only partially or not at all disclose certain information to the principal, for example, about the quality of his performance. The decision on the principal’s contractual partner cannot be based on valid information, which in turn may lead to the selection of an unsuitable contractual partner (adverse selection) (Ebers & Gotsch, 2006; Eisenhardt, 1989; Picot et al., 1999; Voigt, 2002). 1.2 Hidden action and hidden information In contrast to hidden characteristics, the Agency problems hidden action and hidden information, which occur only after signing the contract (ex-post), relate to the efforts of the agent. In the first case, the principal cannot observe the efforts and activities of the agent, or can do so only at a high cost. In contrast, in the second case of hidden information, the actions of the agent can be observed but not professionally assessed by the principal (Picot et al., 1999)...
