Question

(1) Is a CEO using a corporate jet (instead of flying commercial) a sign of severe principal-agent problems within a company? Why or why not?

(2) Why is this a stark example of the principal-agent problem discussed in Chapter 1?

Answer 1

Question 1 and 2)

The principal-agent problem states that though managers are the agents of the owners of the Company, i.e, shareholders and their duty is to maximise their principal's wealth, sometimes these managers end up trying to indulge in activities that serve their own selfish interests, rather than focussing on the interest of shareholders.

Owners want the managers to maximize the value of the Firm which is generally achieved by maximising the profits. Hence, consuming lavish perquisites available to a manager often leads to reduction in profits of the Firm. Such perks include use of a lavish corporate jet by CEO for his business needs where he could have easily saved huge funds by flying commercial. Thus in this case, where the profit maximisation of a Firm leads to value maximisation as well, use of a corporate jet by CEO is a sign of principal-agent problem.

However, in many industries, it is seen than the most profitable companies are not the fastest growing ones as creation of value is also dependent on many other factors other than profits. In such cases, use of a corporate jet by CEO is not a sign of any severe principal-agent problem.

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