BUS202: Principles of Finance

LEARNING OBJECTIVES

• Explain the agency problem.
• Describe the stakeholder relationship and enumerate key stakeholders.

Similar to fiduciary duty is the concept of agency: a relationship in which one party (the agent) is expected to act on behalf of another party (the principal). A company's management, for example, is expected to act on behalf of the board of trustees, who in turn act on behalf of the shareholders.

Unfortunately, there are many documented cases of the agency problem, where an agent has incentives to place personal interest over the principal's. One solution is to try to align the incentives of the agent and principal; performance bonuses and stock grants are two common ways to reward employees directly for creating value for shareholders.

Arguably, this relationship extends further. Each employee has a responsibility to diligently work and fulfill the employment agreement. If a conflict of interest arises, the employee should put personal interests aside or terminate the employment arrangement in a fair manner. Management, however, has a responsibility to the employees as stakeholders (parties affected by the operations of the company) to balance their interests when making decisions. Many decisions in management involve tradeoffs among stakeholders (which include shareholders) which can rarely be simplified to numbers or a simple good/bad analysis.

Opinions differ on which groups should be considered stakeholders and how their claims should be weighed against one another. The narrowest view endorses maximizing shareholder profit as the dominating factor and only considers stakeholders as far as they can affect profit. For example, a subscriber to this view would choose to protect customers only if they thought doing so would ultimately positively contribute to the wealth of the stockholder. A broader view would include employees, suppliers, customers, investors, communities (and their governments) where the business operates, etc. Even competitors can be considered stakeholders!

In dealing with the balance between stakeholders, we suggest following one very important guideline: that human dignity is paramount. No manager has the right to consider themselves superior to their employees, suppliers, customers, etc. Treating people as a means to an end cannot ultimately be good for business. This might mean considering the rights of customers to use and resell a product or the rights of employees to a just wage for their work. Of course, in more extreme cases, it can mean considering the effects of addictive substances or even slave labor or human trafficking.

Beyond this principle, there is much room for debate about the proper balance of stakeholder concerns. Businesses are very complex, and a comprehensive list of guidelines could not possible cover every situation a manager will experience in his or her career. This is why it is so important to have managers who are willing and able to exercise their own ethical judgment!