Question

What is the agency problem? And, Why does the agency problem not exist in a proprietorship? Or does it?

Identify a few sources of the agency problem.

Answer 1

The agency problem is a conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The agency problem does not exist without a relationship between a principal and an agent.

In corporate finance, the agency problem usually refers to a conflict of interest between a company's management and the company's stockholders.

Agency problem not exist in proprietorship because:

Agency conflicts typically arise when there is a separation of ownership and management of a business.

In a sole proprietorship and a small partnership, such separation is not likely to exist such extent.

The main reasons or sources for agency problem is:

There can be various causes of agency problems. These causes differ from the position of an individual in the company.

The root cause of these problems is the same in all cases that are mismatch or conflict of interests.

In the case of employees, the reason would be the failure of stockholders to meet employees’ expectations with respect to salary, incentives, working hours, etc.

In the case of customers, the cause would be the failure of stockholders to meet customers’ expectations like the sale of poor quality goods, poor supply, high-pricing, etc.

In the case of management, the causes of agency problems could be the misalignment of goals, separation of ownership and management, etc.