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Explain agency problems in the context of modern corporations with examples

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Question: - Define agency problem and explain agency problems in the context of modern corporations with examples. Please support your answer with some classic academic works.

Answer:-

Agency problem deals with the issue of directors running a corporation while shareholders own it. In the past, there was a concern that the directors may well not work in the shareholders' best interests. A principal hires an agent to complete a task on their behest. The connection between a principle and their agent is referred to as agency. Due to trust issues in the good conscience of agents, principals bear agency costs in regulating agency conduct. When an agent agrees to perform a work on behalf of a principal, they become answerable to the principal. That principal holds the agent accountable.(Brahmadev Panda, 2017)

Companies listed on a stock exchange, like the London Stock Exchange, are frequently exceedingly complicated and require a lot of capital to fund them, i.e. they frequently have a big number of shareholders. Because of an issue with reward or incentives & the existence of choice in task fulfilment, the agency has a dilemma. If an agent is given an incentive to operate in a way which is not in the best interests of the principal, the agent may be persuaded to do so. In the plumbing scenario, the plumber may be capable of making 3 times as much income by suggesting a service that the agent doesn't really require. The presence of an incentive (3 times the compensation) contributes to the agency problem.

Experienced managers (BOD) are entrusted with running the company on shareholders' behalf. Directors (agents) owe a fiduciary duty to their firm's shareholders (principal) (often referred to as "representing the interests of the shareholders" in company. Because ownership and control are separated, directors and shareholders may have competing interests.

The agents' goals, such as a need for a high pay, a substantial bonus, and director status, will vary with the principal's goals. stakeholders' maximisation of wealth.

Real life example of principle and shareholder relationship problem. Many of the more well-known cases of the agency problem are Ponzi schemes. According to agency theory, these issues are exacerbated by a lack of monitoring and incentive alignment. Many investors fall prey to Ponzi scams, believing that managing funds outside of a traditional financial institution will save them money and cut fees.

He guaranteed his investors returns that were greater than those offered by most investment businesses and banks at the time. Almost all of his investors turned a blind eye because they were so attractive. Madoff deposited their funds in a savings account and used newly invested funds to support redemption demands.

When he was unable to repay his investors, his ruse came to an end, and he surrendered. Madoff was eventually charged with and guilty of criminal offences as a result of his acts.(Amoah, 2018).

The Enron scandal is a well-known instance of the agency problem. Enron's board of directors had a statutory duty to guarantee and advance the interests of shareholders, but a few inducements to do so. However, many observers believe the business failed to fulfill its regulatory duty and refused its monitoring responsibilities, leading to the firm's illegal activities. After an accounting fraud that led to billion dollars in damages, the corporation went bankrupt.(THOMAS, 2012).

 

Companies owned and managed by same people - >>>> Expansion required investors (Shareholders – Limitted Liability ) >>>> Delegated running of company managers(Agents) >>> Saparation of Goals >>>> Agency Problem

 

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