Agency problem

The Agency Problem

The Agency Problem is one that is currently being faced by numerous major corporations all across the globe today. This problem is also known as the Principal-Agent Problem in some cases. Many organizations are currently facing this particular problem due to the simple fact that many organizations have a very similar structure which normally would include the Principal and the Agent.

The Principal would normally consist of the company owner or owners and the share holders. The Agents would be the actual individual or organization vested with the responsibility to accommodate the anticipated intentions and interest of the Principal in whatever the task may be. So essentially to further illustrate this idea and shed more light on the subject Agency theory states that the role of the board of directors is to be the independent intermediary, the broker or the middle man between the Principals, who are the corporations main source of capital and other necessary resources required to keep operations running smoothly. The other party involves the Agents. The agents are the individuals who are obligated by contract to assign the direction of the resources. Essentially, they are the ones that use the corporation’s available resources to accomplish tasks. The actual problem now arises when a conflict of interest arises between the Principal and the Agent. The Principal is supplying the resources in order to have the operations run in a certain way as described and stated out by the Principal. The agent on the other hand is expected to perform tasks in a certain way which is to the interest of the Principal.

In order to guarantee that the agent performs tasks according to the principal, the Principal includes added incentives which are achieved only if certain measures are met. Let us look at the following example; let us assume a Pizza shop. The Principal in this case would be the owner of the pizza shop/restaurant while the agent or agents would be the pizza delivery boys who are counted on to get there in no more than 30 minutes or a similar standard otherwise the pizza is free!! From this example, we can see that the agents are placed in the position to use resources which incur agency costs such as the delivery vehicle, gas and other costs of operating the vehicle such as insurance which do not come out of the delivery boy's pay check. The delivery boys do so in order to complete a task that will be beneficial to the principal. The "Problem" now arises when the agent has no say-so over how these resources are used to accomplish the task by the agent. But the good thing about the Agency Problem is that it is an identified problem which means it can be corrected and solved. There are a number of ways to tackling this problem but to be logical, it makes best sense to have an incentive factor or reward placed into the requirements to solving the problem. The idea is that when incentives exist (Bonuses or possible promotion after a number met requirements) the agent is more than likely inclined to actually perform the task which he or she is obligated to perform by contract as though it was in their own interest. Now that there is an added incentive, it is in the agents interest to perform in outstanding standards in order to achieve that added incentive.

Johnson, M. Paul. “A Glossary of political terms.” Department of Political Science, 7080 Haley Center, Auburn University, Auburn, AL 36849

http://www.auburn.edu/~johnspm/gloss/agency_problem