principal-agent problems

2. The problem of disputes and
dilemma between the owners and
the management or the mangers
is called as the principal-agent
problem.
What is the principal-agent problem?

3. The ownership may be concentrated or
diffused ..
That is there may be one owner or more than
one owner .
If the owners are more than one then they
are called as partners.
Ownership

4. If the number of owners is numerous
then they are called shareholders.
There are two types of stock holders one
is controlling shareholders and minority
share holders.
The controlling share holders will poses
more than 50% of the total shares

5. Management
The relationship between shareholders and
professional managers is a relationship between
principals and agents
The managers will be appointed my the
board of the owners ( controlling) .
 There may be a CEO who performs all
activities of a owner and a manager.
This is called as CEO duality.

6. Principal-Agent conflicts
Share holders
( principal)
Management
(Agent)
conflicts

7. Imagine a firm hires a new employee.
His job includes examining the competing bids from
the firm’s suppliers and preparing reports on the merits
of each.
How does the firm know the employee will handle this
task dutifully?
It may be easier to simply make up facts than to
thoroughly research the bids. Or the employee may favor
one supplier over another for reasons completely
unrelated to the merit of the proposal — because of a
family connection for instance.

8. This is an example of what economists call the
“principal agent problem.”
 In this scenario, the employer is the“principal” and
the employee is the “agent.”
The interests of agents are not perfectly aligned with
those of the principals.
 Yet the principals can only imperfectly monitor the
actions of the agents.
This means that agents can advance their own
interests at the expense of those of the principals.

9. The problem arises where the two parties have
different interests and asymmetric
information (the agent having more
information), such that the principal cannot
directly ensure that the agent is always acting in
its (the principal's) best interests, particularly
when activities that are useful to the principal
are costly to the agent, and where elements of
what the agent does are costly for the principal
to observe.

10. Moral hazard and conflict of interest may
arise. Indeed, the principal may be sufficiently
concerned at the possibility of being exploited
by the agent that he chooses not to enter into a
transaction at all, when that deal would have
actually been in both parties' best interests: a
suboptimal outcome that lowers welfare
overall. The deviation from the principal's
interest by the agent is called "agency costs"

11. EXAMPLES:-
1)The managers work for their self interest and
they don’t care about the company’s mottos and
intension to increase the profits and wealth of the
owners i.e principals.
This problem arises when there is no proper
monitoring on the deeds and ideas the managers .

12. 2) The agents work for other companies or persons
other than his host company . The other company may
be a competitor for the host company i.e. they will
join hands with other people which may degrade the
company’s interest of profit maximization.
The problem can be solved my selecting the
candidates based on his moral values and his past .
The principals should be conscious about the steps
and decisions taken by the agents . The agents should
be responsible to the principals.

13. 3) The Agents can misuse their power to increase his
wealth he can sell important and confidential
information to the competitors and he may be cause
for the decrease the share value of the company .
This problem can be solved by choosing one of the
owner as the CEO , so that he may not work for his
own company’s destruction.

14. Conflicts & Solutions :-
Every problem has a solution and there are many
solutions for this principal-agent conflicts , few of
them are ..
Allowances
Incentives
Bonus
Gifting the company’s shares
Effective HRD
Transparency
Increasing responsibility among the agents