Problems with the Agency Relationship
PROBLEMS WITH THE AGENCY RELATIONSHIP
If you are the sole owner of a business, you make the decisions that affect your own well-being. But what if you are a financial manager of a business and you are not the sole owner? In this case, you are making decisions for owners other than yourself; you, the financial manager, are an agent. An agent is a person who acts for—and exerts powers of—another person or group of persons. The person the agent represents is referred to as the principal. The relationship between the agent and his or her principal is an agency relationship. In an agency relationship, the agent is charged with the responsibility of acting for the principal. Is it possible the agent may not act in the best interest of the principal, but instead act in his or her own self-interest? Yes—because the agent has his or her own objective of maximizing personal wealth. In a large corporation, for example, the managers may enjoy many fringe benefits, such as golf club memberships, access to private jets, and company cars. These benefits (also called perquisites or perks) may be useful in conducting business and may help attract or retain management personnel, but there is room for abuse. What if the managers start spending more time at the golf course than at their desks? What if they use the company jets for personal travel? What if they buy company cars for their teenagers to drive? The abuse of perquisites imposes costs on the company—and ultimately on the owners of the company. There is also a possibility that managers who feel secure in their positions may not bother to expend their best efforts toward the business. This is referred to as shirking, and it too imposes a cost to the company.
Finally, there is the possibility that managers will act in their own self-interest, rather than in the interest of the shareholders when those interests clash. For example, management may fight the acquisition of their own company by some other company, even if the
If you are the sole owner of a business, you make the decisions that affect your own well-being. But what if you are a financial manager of a business and you are not the sole owner? In this case, you are making decisions for owners other than yourself; you, the financial manager, are an agent. An agent is a person who acts for—and exerts powers of—another person or group of persons. The person the agent represents is referred to as the principal. The relationship between the agent and his or her principal is an agency relationship. In an agency relationship, the agent is charged with the responsibility of acting for the principal. Is it possible the agent may not act in the best interest of the principal, but instead act in his or her own self-interest? Yes—because the agent has his or her own objective of maximizing personal wealth. In a large corporation, for example, the managers may enjoy many fringe benefits, such as golf club memberships, access to private jets, and company cars. These benefits (also called perquisites or perks) may be useful in conducting business and may help attract or retain management personnel, but there is room for abuse. What if the managers start spending more time at the golf course than at their desks? What if they use the company jets for personal travel? What if they buy company cars for their teenagers to drive? The abuse of perquisites imposes costs on the company—and ultimately on the owners of the company. There is also a possibility that managers who feel secure in their positions may not bother to expend their best efforts toward the business. This is referred to as shirking, and it too imposes a cost to the company.
Finally, there is the possibility that managers will act in their own self-interest, rather than in the interest of the shareholders when those interests clash. For example, management may fight the acquisition of their own company by some other company, even if the