Agency Problems
1.
The agency theory is a supposition that tries to develop an explanation for the relationship that exists between principals and agents in a business (Pfeffer and Salancik, 2003). Normally, agency theory involves developing solutions to the problems that might exist in agency relationships, such as problems between the principals and agents of the principals.
One aspect of agency theory is separation ownership. The relationship developed between the owners of the company (shareholders) and the agent (directors) in a company creates a separation in the ownership and control of the company. Major companies such as the ones listed in popular stock markets are very complex and require significant investment in equity for their funding. Therefore, they normally have a large number of shareholders (Schulze et al. 2001).These shareholders delegate the role of controlling the company to directors. In the management of such a company, shareholders play a passive role. Directors own a very small percentage of the company. In such a situation, the owners of the company (shareholders) do not control the organization. This separation between owners and controllers of a corporation causes potential conflicts of interests between the shareholders and the directors.
Asymmetric information is another aspect of the agency theory. This aspect relates to a situation where one party in the agency relationship has more relevant information than the other party does. In this case, the directors of the company are usually more aware of the market factors and other issues relating to the operation of the company. On the other side, the principals are usually less informed on matters relating to market factors and operation of the company (Ballwieser et al. 2012). The difference brought by this lack of relevant information by one party in the agency relationship, leads to conflicts of interest due to misinformation where the principals might struggle in their bid to ensure that the directors are always working in their best interests.
A conflict of interest in the principal-agent relationship exists where it is expected of one party in the relationship to act in such a way it promotes the best interests of the other party (Shapiro, 2005). The problem arises where the interests of the agent, which might differ from the best interest of the principal, normally motivate the agent. An agent motivated by their own interests is likely to act in a different way from the principal’s expectations, hence, the conflict of interests.
2.
An instructive example of how the agency problem may occur is seen in the case of aerospace leader Boeing. There were over 130,000 shareholders in Boeing between 1998 and 2001. Most of these shareholders were employees of Boeing who had purchased the company stocks by the use of their retirement plans (Politis, 2015). However, the company executives decided to buy back their own stock so that the share price went down. In doing this, the executives damaged the retirement accounts of their employees.
The agency problem can be very catastrophic. The case of Enron collapse in 2001 demonstrates this assertion. The officers of the company together with the board of directors used false accounting reports so that Enron stock were sold at higher prices, thereby making the stock look as if it was more valuable than its actual value (Currall and Epstein, 2003). When the scandal was discovered, the energy giant collapsed, leading to major losses for stockholders. The fact that the directors of the company acted in their best interests led to eventual losses for the stakeholders who had hired them to manage the company.
The case of Goldman Sachs is another example of potential agency problems. In this case, financial analysts decided to invest against their client’s best interests. Goldman Sachs, an investment giant, together with other brokerage houses created collateralized debt obligations, which were mortgaged-backed securities. Gold Sachs then sold these collateralized debt obligations in “short”, with the belief that the mortgages were about to undergo foreclosure (Taibbi, 2009). The housing bubble of 2008 occurred during this period and the collateralized debt obligations had their values dropping very fast. In the end, short-sellers made huge profits while a large number of homeowners and investors lost almost everything due to this collapse.
3.
In the case of aerospace giant Boeing, the appropriate mechanism for dealing with such an agency problem is the economic calculation and competition mechanism (Fama, 1980). Other competitive executives in the same field can discipline the executives at Boeing by taking care of their employee investments in the stocks of the company. Therefore, employees might consider switching to the company that is more interested in taking care of their interests. Implementing the economic calculation and competition mechanism will reduce the chances of such a situation occurring in future as the organization will be aware of the competitive market and will not allow activities that may lead to loss of their employees to competitors.
The case of Enron can be governed by the system of reputations. In this case, the reputation mechanism will help the organization directors avoid activities that may lead to damage of the company’s reputation. The directors cannot use false accounting, as they are aware that discovery of such malice leads to a major loss in terms of reputation for the company (Pujol et al. 2002).
The case of Goldman Sachs can be prevented in future if the investments clients use the hostile takeover mechanism (Cuervo, 2002). Bad management of the clients’ investments calls for a change from the clients where the shareholders in the company are forced to change the directors of the organization. A better management team is placed in charge of the corporation as they struggle to regain their potential value.
Bibliography
Pfeffer, J. and Salancik, G.R., 2003. The external control of organizations: A resource dependence perspective. Stanford University Press.
Schulze, W.S., Lubatkin, M.H., Dino, R.N. and Buchholtz, A.K., 2001. Agency relationships in family firms: Theory and evidence. Organization science, 12(2), pp.99-116.
Ballwieser, W., Bamberg, G., Beckmann, M.J., Bester, H., Blickle, M., Ewert, R., Feichtinger, G., Firchau, V., Fricke, F., Funke, H. and Gaynor, M., 2012. Agency theory, information, and incentives. Springer Science & Business Media.
Shapiro, S.P., 2005. Agency theory. Annual review of sociology, pp.263-284.
Politis, J., 2015, November. The Relationship Between Servant Leadership and Agency Problems: A Conceptual Model. In ECMLG2015-11th European Conference on Management Leadership and Governance: ECMLG2015 (p. 345). Academic Conferences and publishing limited.
Currall, S.C. and Epstein, M.J., 2003. The Fragility of Organizational Trust:: Lessons From the Rise and Fall of Enron. Organizational Dynamics, 32(2), pp.193-206.
Taibbi, M., 2009. The great American bubble machine. Rolling Stone, 9, p.1.
Fama, E.F., 1980. Agency Problems and the Theory of the Firm. The journal of political economy, pp.288-307.
Pujol, J.M., Sangüesa, R. and Delgado, J., 2002, July. Extracting reputation in multi agent systems by means of social network topology. In Proceedings of the first international joint conference on Autonomous agents and multiagent systems: part 1 (pp. 467-474). ACM
Cuervo, A., 2002. Corporate governance mechanisms: A plea for less code of good governance and more market control. Corporate Governance: An International Review, 10(2), pp.84-93.
