Question

One of the most challenging issues in the financial management of the enterprise is the possible separation of ownership from management resulting in the so-called principal agent problem. Define the agency problem, explain possible ways to alleviate the agency problem and discuss differences in across global markets.

Answer 1

A situation in which agents of an organization use their authority for their own benefit rather than that of the principals. The agency problem also refers to simple disagreement between agents and principals.In these problems related to a company, The management is shareholder's agent and it has to work upon shareholder's behalf, But in several instances, it has been seen that Management is working for it's own benefit. Example in case of Lehman brothers,The management worked in it's own interest and that blew up the whole company.

Possible ways to alleviate the agency problem are as follows-

1.Illustrating the agency problem- The problem between both the principal and the agent must be clearly defined in order to have a clear resolution plan.

2.Full Transparency of operations- There must not be any kind of disparity in knowledge between both the principal and the agent. The disclosure should be properly made and roles should be properly defined.

3.Restrictions on the agent's capabilities- There must be some limitations put in the place on the agent's overall capability which helps the principal in maintaing a control and upper hand in the whole relationship.

4.Proper compensation and commission to the agents must be predefined which will help in matching his personal goals to that of principal.

Agency problems in general are related to the structure of the ownerrship and control and there are different type of copperation and coordination mechanism all across the globe which helps in countering such principal agents problem. Different types of approaches are based upon different remuneration structure to counter these agency problem. The primary emphasis is laid upon congruence of goals of both parties to resolve agency conflicts.