Question

At the heart of Agency Theory are the twin issues of Goal Conflict and Risk Sharing.  

Discuss each of these

1. what each is;
2. why it creates problems; and
3. what can be done to counteract it (only one option is needed).

Answer 1

Agency is about the relationship between principle and his agent. And agency theory is a principle which is used to resolve the issues between principle and it's agent. Twin issues are at the heart of agency theory that is goal conflict and risk sharing.

1. Goal conflict : when the goal of principle doesn't matches with the goal of agent at that time goal conflict is there. Goal is very important for each of them. Principal while doing transaction through agent at that time he is thinking more about the achievement of its goal.

The assumption of agency theory is that both principle and agent work for their self interest.

Risk sharing is also an issue or problem .when principle share risk along with sharing of authority and responsibilities that is refer as risk sharing. Risk is very important for an businessman. Nobody is ready to take the risk ,everyone wants the fruits from it. So, agency theory help to solve this issue also.

2. Goal conflict creates problem because firstly there are two individuals :one is principle and other is agent. And everyone has their own goals. An agent is working for principle but then too he first work for the achievement of his goal whether intentionally or unintentionally. If there is conflict, then ultimatum goal of principle may not be achieved.

Risk sharing issue creates problem because as generally in the relationship of agency, principle doesn't delegate ownership, only some authority to exercise lien for selling , or some rights and responsibilities are given.

3. To solve the problem counteract is done in following ways :

In case of goal conflict,

Incentives and symmetry of information :

Agent work only for benefits which is he doing to derive in the form of commission, etc. There may not be conflict between them if the interest is in non financial terms. Also in case of goal conflict there may be chances that agent is not aware about the goal of principle, at that time also he is unable to act as per principle goal.

In case of risk sharing issue :

Appropriate dilution of ownership :

Normally the whole burden is on principle because he doesn't delegate ownership to agent but if he dilute appropriate proportion of ownership (not whole ownership) that means in form of risk distribution. Or sometimes, risk may be shared by doing a contract with agent by principle on some extra commission (like Del creder agent). Dilution is only one way to overcome this issue. However, if agent is not having ownership then to be burden is on him if he act as a principle in any contract with third party.