Business
Agency Problems
Agency problems refer to conflicts of interest that arise between principals (such as shareholders) and agents (such as company executives) when the agents' actions may not align with the best interests of the principals. These problems can occur due to information asymmetry, differing risk preferences, and the separation of ownership and control in a business. Resolving agency problems is crucial for ensuring effective corporate governance.
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eBook - ePubOperational Risk Management
Organizational Controls and Incentive System Design
- Jasmijn Bol, Jenna M. Blanche(Authors)
- 2021(Publication Date)
- Business Expert Press(Publisher)
A board’s composition, as well as its rights and responsibilities, depends on the organization; but, in general, boards advocate for the interest of the key principals by providing advisory and oversight of top management. In a typical publicly traded corporation, the shareholders are the key principals, and the CEO is the agent. At the same time, the CEO is the principal, and senior managers are the agents; senior management is again the principal for middle management, and so on. Between each hierarchical level of an organization resides an agency relationship, in which subordinates are hired to act on behalf of supervisors, and hence, Agency Problems are imminent. If the organization is privately owned, there will be a similar agency relationship between its owners (principals) and top management (agents), unless top management holds 100 percent ownership; in that case, there is no agency problem at this hierarchical level, as top managers are the owners and therefore representing themselves. However, the potential for Agency Problems persists at the lower hierarchical levels. Information Asymmetry Managing Agency Problems is complicated by the fact that oftentimes there is information asymmetry between principals and agents; namely, the agents possess more or better-quality information than the principals. While principals have a general awareness of agents’ responsibilities, agents possess the intricate details about the tasks and decisions being performed on the principals’ behalf. This disproportionate relationship invokes instability and distrust. Consider, for example, a CEO of a Fortune 500 company. The CEO has far more information about the appropriateness of strategic actions than any of the shareholders
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