Agency and Conflict of Interests
buttons.Defining Agency Conflicts
Agency conflicts can occur when the agent's incentives do not align with the principal's. The agency view of the corporation
posits that the decision rights (control) of the corporation are
entrusted to the manager to act in shareholders' (and other parties')
interests. Partly as a result of this separation, corporate governance
mechanisms include a system of controls intended to help align managers'
incentives with those of shareholders and other stakeholders.
The principal-agent problem or agency dilemma, developed in economic theory, concerns the difficulties in motivating one party (the "agent") to act on behalf of another (the "principal"). The two parties have different interests and asymmetric information (the
agent having more information), such that the principal cannot directly
ensure that the agents are always acting in its (the principals') 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. Moral hazard and conflict of
interest (COI) may thus arise.
Conflict of Interest Principal-agent problems - which arise when managers act on behalf of a firm and its investors - include potential conflicts of
The deviation from the principal's interest by the agent is
called "agency costs." Agency costs mainly arise due to contracting
costs, the divergence of control, the separation of ownership and
control, and the different objectives (rather than shareholder
maximization) of the managers. When a firm has debt, conflicts of interest can also arise between stockholders
and bondholders, leading to agency costs for the firm.
Examples of agency costs include that borne by shareholders (the principal) when corporate management (the agent) buys other companies to expand its power instead of maximizing the value of the corporation's worth or by the constituents of a politician's district (the principal) when the politician (the agent) passes legislation helpful to large contributors to their campaign rather than helpful to voters.
Much of the contemporary interest in corporate governance is concerned with mitigating conflicts of interest between stakeholders. A conflict of interest occurs when an individual or organization is involved in multiple interests that may lead to conflicts in their ability to act in the best interest of one party.
In addition to conflicts of interest between managers, shareholders, and bondholders, conflicts of interest can also occur among other company stakeholders, such as the board of directors, employees, government, suppliers, and customers. COI is sometimes termed "competition of interest" rather than "conflict", emphasizing a connotation of natural competition between valid interests rather than violent conflict. At other times, conflicts of interest are confused with cases that might better be termed "corruption," such as bribe-taking or fraud.
Key Points
- The agency view of the corporation posits that the decision rights (control) of the corporation are entrusted to the manager to act in shareholders' interests. Control systems in corporate governance can help align managers' incentives with those of shareholders and other stakeholders.
- The principal–agent
problem concerns the difficulties in motivating one party (the
"agent"), to act on behalf of another (the "principal"). The two parties
have different interests and asymmetric information. Moral hazard and conflict of interest may thus arise.
- The deviation from the principal's interest by the agent is called
"agency costs. " Agency costs mainly arise due to contracting costs and
the divergence of control, separation of ownership and control, and the
different objectives (rather than shareholder maximization) of the
managers.
- Much recent interest in corporate governance is concerned with mitigation of the conflicts of interests between stakeholders. These occur when an individual or organization is involved in multiple interests that may lead to conflicts in their ability to act in the best interest of one party.
Terms
- Moral Hazard – The prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.
- Agent – One who acts for, or in the place of, another (the principal), by authority from him; one intrusted with the business of another; a substitute; a deputy; a factor.
- Principal – One who directs another (the agent) to act on one′s behalf.
Source: Boundless Finance, https://ftp.worldpossible.org/endless/eos-rachel/RACHEL/RACHEL/modules/en-boundless-static/www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-field-and-goals-of-financial-management-1/agency-and-conflicts-of-interest-28/index.html
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