Question

Examine the agency relationship of managers and stockholders:

*Describe the agency conflict that is created in corporations

*Identify the stakeholders involved in an agency conflict

*Provide three strategies to mitigate this conflict between the relevant parties

Answer 1

An agency relationship is established when a principal hires an agent to perform some tasks or duties. A conflict arises when there is a conflict of interest between the needs and interest of the principal and the agent. This is what is referred to as an “agency problem”. One of the primary agency relationship and thus the problem in today’s corporate culture is the relationship between the managers and the stockholders of the company.

As per the “agency view”, the decision-making rights of a corporation should be entrusted to a manager, so that he or she can act in the interest of the shareholders and the company at large. It is at this instance “agency costs” comes up when the agent (manager) behaves in a manner which is in deviation or in contrast from the principal’s (stockholders) interest. The top management, the CEO and the other top executives are responsible for making decisions about the company’s strategy and policy. The stockholders, on the other hand, legally own the stocks of the firm and have the rights to sell those shares, vote on directors nominated by various boards, and some other privileges. As can be seen, the stockholders concede most of their rights to the managers.

In an attempt to benefit the stockholders, managers often face conflict of interests. A manager might be tempted to engage in self-dealing and look at transactions benefitting them personally over the stockholders. They might look at acquisitions and wasteful spending in order to expand their power and influence. Additionally, they might resort to fraud by manipulating financial figures to optimize their own bonus and incentives.

Such acts are detrimental for all stakeholders involved with the company not only limiting it to the stockholders and the managers. This would have a severe impact on everyone involved in the day-to-day activities of the company, starting from the employees to its valued customers. Additionally, it would affect its regular creditors and its major suppliers. The spiral effect would affect the entire value chain, bringing the business to a grinding halt.

In order to mitigate this risk, we can look at the below mentioned 3 means for motivating managers to act in the stockholder’s best interest-

1.       Managerial compensation – The structure should retain only competent managers, who are aligned with the company’s and the stockholder’s interests as much as possible. This can be done through the annual salary plus performance bonus if the aligned objective is met. Distribution of Performance shares and Executive stock options based on the company’s performance and the alignment of being future shareholders themselves.

2.       Direct Intervention by stockholders – The large institutional investors holding major shares in big corporations should exert a direct influence on the managers, thereby having a significant impact on the firms’ operations.

3.       Threat of firing and Takeovers – If the stockholders are not happy or satisfied with the current management’s performance, they can encourage the board to change the existing management. Additionally, if the stock price is found to deteriorate due to the company’s performance, the stockholders or competitors may take a controlling stake in the company and bring in their own team as the new top management.