Principal Agency Problem: Causes and Costs
DISCUSS THE CAUSES AND COSTS ASSOCIATED WITH PRINCIPAL AGENCY PROBLEM (10)
Principal agency problem refers to a conflict arising when people appointed (agents) and entrusted to look after the interests of others (principals) use the authority, power or resources for their own benefit instead. It is a pervasive problem and exists in practically every organisation whether a business, church, club or government. Organisations try to solve it by instituting measures such as tough screening processes, incentives for good behaviour and punishments for bad behaviour and watchdog bodies but no organisation can remedy it completely. This is because the costs of remedy usually outweigh the worth of the results.
The agency problem arises because the objectives of managers may differ from those of shareholders. In financial management objective of the shareholders is primarily to maximise profits thus shareholder value, whereas managers may be concerned with personal growth and enrichment through excessive salaries and allowances, which automatically diminishes the profit margins for the shareholders hence the principal agency problem. Managers may also invest in wasteful pet projects or buy more companies to increase their power instead of maximising the value of the corporation’s worth. It is one of the most noticed problems in the current Zimbabwean situation when most companies are not being managed by the owners themselves, especially in the various government parastatals. Another common cause of the agency problem is the asymmetry of information, such that shareholders have access to less information about the company than the managers and directors making it hard for shareholders to monitor the actions and decisions of the management. The managers as the agents therefore have room to pursue their own agendas and the shareholders are left with very little to do due to the information constraint.
The costs associated with the agency problem consists of three main
Principal agency problem refers to a conflict arising when people appointed (agents) and entrusted to look after the interests of others (principals) use the authority, power or resources for their own benefit instead. It is a pervasive problem and exists in practically every organisation whether a business, church, club or government. Organisations try to solve it by instituting measures such as tough screening processes, incentives for good behaviour and punishments for bad behaviour and watchdog bodies but no organisation can remedy it completely. This is because the costs of remedy usually outweigh the worth of the results.
The agency problem arises because the objectives of managers may differ from those of shareholders. In financial management objective of the shareholders is primarily to maximise profits thus shareholder value, whereas managers may be concerned with personal growth and enrichment through excessive salaries and allowances, which automatically diminishes the profit margins for the shareholders hence the principal agency problem. Managers may also invest in wasteful pet projects or buy more companies to increase their power instead of maximising the value of the corporation’s worth. It is one of the most noticed problems in the current Zimbabwean situation when most companies are not being managed by the owners themselves, especially in the various government parastatals. Another common cause of the agency problem is the asymmetry of information, such that shareholders have access to less information about the company than the managers and directors making it hard for shareholders to monitor the actions and decisions of the management. The managers as the agents therefore have room to pursue their own agendas and the shareholders are left with very little to do due to the information constraint.
The costs associated with the agency problem consists of three main
References: K Cloke, J Goldsmith; Resolving Conflicts at Work (2005), Revised Edition O Ramsbotham et al; Contemporary Conflict Resolution (2009), 2nd Edition Independent Commission against Corruption; Managing Conflicts Of Interest In The Public Sector, Guidelines, (November 2004) D Frank; “Capital Markets: Pity The Old Retailer Bondholder” (1989). Shleifer A and RW Vishny (1997); A Survey of Corporate Governance, The Journal Of Finance, Vol. 52, No. 2, pp737-61