Question

Are high-profile principal-agent conflicts increasing or decreasing in frequency? Why do you believe this? Why is corporate governance increasingly important in corporate finance? Why may independent directors be especially important to achieving investors' objectives?

Answer 1

The principal agent problem occurs when the agent starts to work on behalf of the principal. This leads to moral hazard and also may lead to conflict of interest.

The fact that high-profile principal - agent conflicts are increasing is seen in corporate and day to day lives also. Politicians serve as agents of voters (principal) but then they act on behalf of voters. However the politicians may not always act in the best interest of the principal thus leading to principal-agent conflict.

Principal - agent conflict is inherent as the agent selected may start to pursue his-her own goal and put aside the real interest of the principal. This may arise out due to a number of factors but primarily it may be due to greed and short term gains.

Corporate governance standards are increasingly important so that this problem is avoided. This is particularly important in corporate finance where certain high level decisions should be taken by the principal (CEO/MD) of the business and not left to the agent so as to avoid principal - agent conflict.

Independent directors would help in notifying biases and self interest motives of the agent if any. They would work as an unbiased source from which to seek help in case the principal is biased in favor of the agent. The principal may also get convinced by the agent. Independent directors step in to show the mirror to the principal to make him see the truth to avoid moral hazard and conflict of interest.