tejas.gaikwad.1044
Tejas Gaikwad
A conflict arising when people (the agents) entrusted to look after the interests of others (the principals) use the authority or power for their own benefit instead. It is a pervasive problem and exists in practically every organization whether a business, church, club, or government. Organizations try to solve it by instituting measures such as tough screening processes, incentives for good behavior and punishments for bad behavior, watchdog bodies, and so on but no organization can remedy it completely because the costs of doing so sooner or later outweigh the worth of the results. Also called principal-agent problem or principal-agency problem.
Agency problem is a one of a kind problem which arises due to a conflict of interest. Man is selfish by nature and such a problem occurs when an agent who is entrusted with a responsibility towards a principal keeps his own self interest over the interest of the principal whom he is supposed to represent. Such a problem can never be completely ruled out of a business it is always present to some extent. The most common form of its occurrence in a business scenario is that the managers have the goal of maximizing shareholder wealth whereas at times they put maximizing their own wealth ahead of their goal.
In political science and economics, the principal–agent problem or agency dilemma concerns the difficulties in motivating one party (the "agent"), to act in the best interests of another (the "principal") rather than in his or her own interests. Common examples of this relationship include corporate management (agent) and shareholders (principal), or politicians (agent) and voters (principal).[1] For another example, consider a dental patient (the principal) wondering whether his dentist (the agent) is recommending expensive treatment because it is truly necessary for the patient's dental health, or because it will generate income for the dentist. In fact the problem potentially arises in almost any context where one party is being paid by another to do something, whether in formal employment or a negotiated deal such as paying for household jobs or car repairs.
The two most common agency problems are "adverse selection" and "moral hazard." Adverse selection is the condition under which the principal cannot ascertain if the agent accurately represents his ability to do the work for which he is being paid.
Example:-
"Agency Problem" Within Boards of Directors, Say Strategic-Management Researchers
Corporate boards may have disincentives to act in shareholders' best interest.
The fall of Enron demonstrates that an inherent management problem previously thought to occur only among a company's top managers also occurs within a company's board of directors, according to two strategic-management researchers at the University at Buffalo School of Management.
In Enron's case, the existence of the "agency problem" within its board of directors is partly to blame for the company's mismanagement and apparent unethical behavior, say John Stephan and Harold Star, assistant professors of management science and systems, who are researching the role of boards and CEOs in setting corporate strategy.
"The agency problem states that because top managers are typically not owners of a company, they can't be trusted to act in the best interest of those who do own the company -- the shareholders," says Stephan. "Boards of directors were seen as a solution to the agency problem because they have a legal responsibility to protect and serve the shareholders.
"But what the Enron case illustrates is that the agency problem also exists within a company's board of directors," Stephan adds. "Boards, too, have incentives not to act in the best interest of shareholders."
According to Stephan and Star, the agency problem at Enron and other companies often is created because the CEO also serves as chairman of the company's board of directors.
"When the chairman is the CEO, then the nature of information that goes to the board is often distorted," says Star. "Making matters worse, the CEO typically stacks the board with cronies and supporters.
"As a result, the oversight role of the board is very easily co-opted into a rubber stamp role," he adds. "That was the case at Enron."
According to Stephan and Star, the Enron case should prompt a lot of re-thinking about the role of the board of directors and whether it's better or worse for a board to own shares of a company.
"The general feeling has been that board members should own shares if they are to represent the shareholders," says Stephan. "But what we're learning from Enron is that when board members own shares, there's a disincentive to ask the really tough questions for fear that those questions will drive down the stock prices."
Adds Star, "The scary thing about Enron isn't Enron. It's that Enron may be just the tip of the iceberg. There are lots of companies who have boards that are closing their eyes to some pretty shady practices."
Solution to Agency Problem:-
The solution (which is closely related to the moral hazard problem) is to ensure the provision of appropriate incentives so that agents act in the way principals wish them to.
Even in the limited arena of employment contracts, the difficulty of doing this in practice is reflected in a multitude of compensation mechanisms (‘the carrot’) and supervisory schemes.
Agency problem is a one of a kind problem which arises due to a conflict of interest. Man is selfish by nature and such a problem occurs when an agent who is entrusted with a responsibility towards a principal keeps his own self interest over the interest of the principal whom he is supposed to represent. Such a problem can never be completely ruled out of a business it is always present to some extent. The most common form of its occurrence in a business scenario is that the managers have the goal of maximizing shareholder wealth whereas at times they put maximizing their own wealth ahead of their goal.
In political science and economics, the principal–agent problem or agency dilemma concerns the difficulties in motivating one party (the "agent"), to act in the best interests of another (the "principal") rather than in his or her own interests. Common examples of this relationship include corporate management (agent) and shareholders (principal), or politicians (agent) and voters (principal).[1] For another example, consider a dental patient (the principal) wondering whether his dentist (the agent) is recommending expensive treatment because it is truly necessary for the patient's dental health, or because it will generate income for the dentist. In fact the problem potentially arises in almost any context where one party is being paid by another to do something, whether in formal employment or a negotiated deal such as paying for household jobs or car repairs.
The two most common agency problems are "adverse selection" and "moral hazard." Adverse selection is the condition under which the principal cannot ascertain if the agent accurately represents his ability to do the work for which he is being paid.
Example:-
"Agency Problem" Within Boards of Directors, Say Strategic-Management Researchers
Corporate boards may have disincentives to act in shareholders' best interest.
The fall of Enron demonstrates that an inherent management problem previously thought to occur only among a company's top managers also occurs within a company's board of directors, according to two strategic-management researchers at the University at Buffalo School of Management.
In Enron's case, the existence of the "agency problem" within its board of directors is partly to blame for the company's mismanagement and apparent unethical behavior, say John Stephan and Harold Star, assistant professors of management science and systems, who are researching the role of boards and CEOs in setting corporate strategy.
"The agency problem states that because top managers are typically not owners of a company, they can't be trusted to act in the best interest of those who do own the company -- the shareholders," says Stephan. "Boards of directors were seen as a solution to the agency problem because they have a legal responsibility to protect and serve the shareholders.
"But what the Enron case illustrates is that the agency problem also exists within a company's board of directors," Stephan adds. "Boards, too, have incentives not to act in the best interest of shareholders."
According to Stephan and Star, the agency problem at Enron and other companies often is created because the CEO also serves as chairman of the company's board of directors.
"When the chairman is the CEO, then the nature of information that goes to the board is often distorted," says Star. "Making matters worse, the CEO typically stacks the board with cronies and supporters.
"As a result, the oversight role of the board is very easily co-opted into a rubber stamp role," he adds. "That was the case at Enron."
According to Stephan and Star, the Enron case should prompt a lot of re-thinking about the role of the board of directors and whether it's better or worse for a board to own shares of a company.
"The general feeling has been that board members should own shares if they are to represent the shareholders," says Stephan. "But what we're learning from Enron is that when board members own shares, there's a disincentive to ask the really tough questions for fear that those questions will drive down the stock prices."
Adds Star, "The scary thing about Enron isn't Enron. It's that Enron may be just the tip of the iceberg. There are lots of companies who have boards that are closing their eyes to some pretty shady practices."
Solution to Agency Problem:-
The solution (which is closely related to the moral hazard problem) is to ensure the provision of appropriate incentives so that agents act in the way principals wish them to.
Even in the limited arena of employment contracts, the difficulty of doing this in practice is reflected in a multitude of compensation mechanisms (‘the carrot’) and supervisory schemes.