Question

What is an agency problem? Explain in a few sentences what is an agency problem is? What is the nature of the problem? And give an example or two.

Answer 1

Agnecy problem means the problem of alignment of objectives of management (Agent) and owners(Principal). In the present scenario, the owners of the company appoint the managers for the effective running of the company. However sometimes, there may be a conflict in the objectives of the owners and that of managers. So the nature of the problem is like principal agent problem, where agent may be acting in certain ways, whihc are not well regarded by the principal. For example, if the company has the excess cash in its hands, the owners ay want it to get distributed, but the agent or the management wants to retain the cash to finance any new investement. Similarly sometimes to improve their performance, management may decide to extend credit to certain risk category customers so that sales can be inflated. However its not in the best interest of owners.