Question

An agency relationship occurs when a principal hires an agent to perform some duty. A conflict, known as an "agency problem," arises when there is a conflict of interest between the needs of the principal and the needs of the agent.

Discuss the possibility of agency problems in a business that is a (a) proprietorship, (b) partnership with seven partners, and (c) corporation with 100,000 stockholders. Make you case and back up your opinions.

Answer 1

a. Proprietorship - There cannot be any agency problem since there is only one owner in the business. There is no "agent" or a "principal" for an agency problem to arise.

b. Partnership with seven partners - Here all the seven partners are the principals and gents themselves. If all the seven partners are involved in the business on a regular basis, then there is very little chance of an agency problem. However, if there are some partners who have invested and other partners who run the business there could be a problem between the partners who invested (principal) and the partners who run the business (agents)

c. Corporations with 100,000 shareholders: Here there will be a definite case for agency problem. This company would a public company which will have managers to run the business. For example: The investors who are the shareholders (Principal) will want the excess cash the business owns to be paid out as dividends. However, the managers of the company (agents) will want the excess cash to be kept aside for future growth opportunities which may lead to a principal-agent problem.