Critically discuss the possible solutions to the agency problems in modern corporations

Home, - Discuss the possible solutions to the agency problems

Question:-  Critically discuss the possible solutions to the agency problems that may occur in modern corporations.

Answer:- Agency theory states various solutions to agency problem. To alleviate agency difficulties, agency theorists have traditionally assumed a significant function for clear incentive systems, such as binding agreements and monitoring. Due to moral risk and unfavourable selection, history shows that these remedies are insufficient.

"Agency expenditures can be reduced in addition to tracking efforts by the manager's bonding activities (Jensen and Meckling, 1976). Bonding costs are the expenditures incurred by the management to minimisethe agency conflict, which are efforts made at the cost of his own utility. Bonding is nearly impossible to study or quantify in practice(Craig A. Depken, n.d.)."

The employment of bond covenants is yet another answer to this issue. However, enforcing bond covenants for these kind of objectives would necessitate a great deal of surveillance and would very certainly be costly. In reality, according to M.W. McDaniel, "Bondholders and Corporate Governance," 41 The Business Lawyer, 413 (1986), covenants limiting investments and asset disposal are uncommon, and the pattern is toward the abolition of covenants in bond indentures.(Michael Frierman, 2014)

Agreements or laws, in the context of fiduciary ties, can and mostly are used to control principal-agent connections. The Fiduciary Rule is an instance of an effort to enforce the emerging agency problem in financial planner relationships. In the investment advising business, the term fiduciary refers to financial and pension consultants who must work in their customers' greatest advantage. 2 In other words, advisors must prioritise the interests of their clients over their own. The purpose is to safeguard investors from counselors who hide any potential conflicts. So, a contract needs to be there for solving agency problem. (Miller, 2015)

The agency problem can potentially be mitigated by motivating an agent to behave in the principal's best interests. For instance, performance-based pay, direct shareholder involvement, the danger of fire, or the possibility of acquisitions can all encourage a management to behave in the greatest advantage of the company's shareholders.So, there needs to be incentive scheme as a solution for agency problem.

The form of an agent's pay can also be changed by the principal. If, for instance, an agent is paid by the project completion rather than by the hour, there is less temptation to act against the principal's best interests. Furthermore, independent assessments and performance reviews keep the agent responsible for their judgments.

As a conclusion, while it is impossible to completely eradicate the agency problem, principals can take steps to reduce the risk connected with it, which is defined as agency cost. Contracts or laws, in the context of fiduciary ties, are used to control principal-agent relationships. Other strategy is to pay an agent to act in the greatest advantage of principal.  If an agent is rewarded by the project completion rather than by the hour, there will be less temptation to act against the best advantage of principal.

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