The Agency Problem in Business |
Suppose, that you have decided to move overseas for either work or study. You still have property in the country of residence, but you do not have the time to sell them before you move. Now, you hire an agent to sell the property on your behalf. Depending on the contract you have with that agent, if you were going to pay them a commission (a certain percentage of the selling price) then the chance of agency problem occurring in the situation is minimal; because their earnings from the transaction are tied to their performance. What if your agreement is to pay the agent a fixed amount when the property is sold? If you do not have additional conditions attached to this agreement, it would imply that for as long as the property gets sold, the agent will be paid what is due to them pending the contract. Thus, the agent does not have any incentive to find you the best deal. Now, nobody including you want to loose money on a transaction, but what if all that the agent can come up with is short of the profits you were expecting? This scenario then is likely to turn into a conflict of interest in which case the interest of the agent is to sell at whatever price and get paid, while the interest of the owner is to make a profit from selling their property. For the agent waiting for the offer that would satisfy the owner might mean waiting a long time before they earn income, but for the owner going for whatever deal that shows up first may result in a loss. The cost that arise from such conflict of interest between owners (stockholders) and agents (managers) is called agency costs If that sounds a little familiar, it could be from recent media coverage of corporate losses and bonuses that are not tied to performance. During this global recession some companies were caught in a situation where they had to pay executive bonuses despite the fact that the corporations they run recorded historic loses, and thus loss in stockholder's earnings. Whether or not managers will act in the interest of the owners, depends on how such managers are compensated. If the incentives for making sure stockholders interests are met outweighs the interests of managers then you are more likely to see managers interests being in line with those of the stockholders. |
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