EDUCBA

EDUCBA

MENUMENU
  • Free Tutorials
  • Free Courses
  • Certification Courses
  • 250+ Courses All in One Bundle
  • Login
Home Finance Finance Resources Investment Banking Basics Agency Problem
Secondary Sidebar
Finance Blog
  • Investment Banking Basics
    • Trust Fund
    • Short Sale in Real Estate
    • How to Invest in Stocks
    • Penetration Pricing Strategy
    • S Corporation
    • Special Purpose Entity
    • Wholesale Price Index
    • Hyperinflation
    • Stagflation
    • Capital Structure
    • Pecking Order Theory
    • Private Placement of Shares
    • What is Stock Market
    • Pyramid Scheme
    • Introduction to Stock Market
    • Fiscal Policy
    • Trust Account
    • Zombie Company
    • Aggregate Demand (AD)
    • Aggregate Supply
    • Diluted EPS
    • Limited Partnership
    • Leveraged Finance
    • Liquidation
    • Holding Company
    • Kickback
    • Kiting
    • Financial Instrument
    • Finance Charge
    • Free Cash Flow to Firm Formula
    • Personal Income
    • Enterprise Value
    • Joint Liability
    • Return on Average Equity
    • Factor Models
    • Beta in Finance
    • Leverage Ratio
    • Investment Partnership
    • Banker??s Acceptance
    • Internal Sources of Finance
    • Insolvency
    • Intercreditor Agreement
    • Forfaiting
    • Debt Restructuring
    • How to Buy Shares?
    • Indenture
    • Incumbency Certificate
    • In House Financing
    • Independent Director
    • Insourcing
    • Holding Company Examples
    • How to Get Into Project Finance
    • How to Manage Your Money
    • Finance vs Consulting
    • Agency Problem
    • Article of Association
    • Career and Scope After B.Com
    • Capital Rationing
    • Financial Guarantee
    • Corporate Governance
    • FHA Loan
    • Fannie Mae
    • Financial Market
    • Fixed Capital
    • Fixed Rate Mortgage
    • Foreign Corrupt Practices Act
    • Foreign Investment
    • Finance vs Marketing
    • Functions of Financial Markets
    • Grace Period
    • Gift of Equity
    • Greenwashing
    • Hard Money Loan
    • CFO Job Description
    • Corporate Finance vs Investment Banking
    • Corporate Finance vs Project Finance
    • Career After BFM/BAF
    • Form S-8
    • Market Cap vs Enterprise Value
    • Quantitative Analyst Career
    • Leveraged Buyout Model
    • Mistakes in Discounted Cash Flow
    • LBO Analysis
    • Golden Handshake
    • Asset Management Company?
    • Private Placement?
    • Marking to Market?
    • Horizontal Merger
    • Special Purpose Vehicle
    • What is Investment Banking?
    • Spin off vs Split off
    • Vertical Merger
    • Merger and Acquisition Process
    • Conglomerate
    • Horizontal Merger Examples
    • Amalgamation
    • LBO Financing
    • Types of Joint Venture
    • Merger
    • Acquisition
    • Greenmail
    • Reverse Merger
    • Sandbagging
    • Pac Man Defense
    • Backward Integration
    • Poison Pills
    • Green Shoe Option
    • Hostile Takeover
    • Forward Integration
    • Acquisition Financing
    • Types of Acquisition
    • Project Budgeting Template
    • Commercial Bank vs Investment Bank
    • Private Equity vs Venture Capital
    • Degree of Operating Leverage
    • Sales and Trading
    • Revenue Recognition Principle
    • Hedge Fund Strategies
    • Merger Examples
    • Vertical Integration Example
    • Vertical Merger Example
    • Financial Markets
    • Equity Examples
    • Biggest IPO's in History
    • Cross Border Merger and Acquisitions
    • Leverage Buyout
    • Mergers and Acquisitions in India
    • Project Financing in India
    • Investment Banking for Dummies
    • Equity Research Report Rules
    • Mergers and Acquisition in 2013
    • Investment Banking Band Chart
    • IPO For Investors
    • Yield Spread
    • Angel Investor vs Venture Capital
    • CFA vs CA
    • Merger vs Amalgamation
    • Joint Venture vs Strategic Alliance
    • Carees in Banking Exams
    • Facebook IPO
  • Accounting fundamentals (700+)
  • Asset Management Tutorial (200+)
  • Banking (44+)
  • Corporate Finance Basics (373+)
  • Credit Research Fundamentals (6+)
  • Economics (88+)
  • Finance Formula (386+)
  • Financial Modeling in Excel (17+)
  • Investment Banking Careers (29+)
  • Trading for dummies (69+)
  • valuation basics (27+)
  • Insurance Resources (14+)
  • Top Finance Books (7+)
Finance Blog Courses
  • Investment Banking Course
  • Mergers & Acquisition Course
  • Financial Modeling Course

Agency Problem

 

Agency Problem

What is the Agency Problem?

An agency relationship is created when any person or a group of persons, referred to as agents, are appointed to act on behalf of any other person/organization, referred to as the principal. An agency problem arises when he uses his authority for his benefit instead of the principal’s benefit.

Thus, in simple words, an agency problem arises when there is any disagreement or conflict of interest between agent and principal.

All in One Financial Analyst Bundle(250+ Courses, 40+ Projects)
Financial ModelingInvestment BankingUS GAAPCFA-Level 1 & 2
Equity ResearchM & A ModelingPrivate Equity ModelingForex Trading
Price
View Courses
250+ Online Courses | 40+ Projects | 1000+ Hours | Verifiable Certificates | Lifetime Access
4.9 (86,522 ratings)

Key Takeaways

It is an incompatibility between any two parties; wherein one party is bound to act in the best interest of the other. It can arise when the incentives received by the agent are not compensatory enough for them to stay motivated to continue acting in the principal’s best interest.

Start Your Free Investment Banking Course

Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

It can be avoided by compensating each group so that the incentive or compensation keeps them motivated to work for a more significant interest. You may note that agency problems cannot be avoided totally, but they can be reduced.

Example of Agency Problem

One can encounter various scenarios where one can see agency problems. For example, any time when the agents fail to do their duty or take any decision in their interest instead of their commitment is an agency problem.

A simple example can be a bank. The bank pays us interest when we deposit money in our bank account. Now, if the bank management denies paying their interest, it is nothing but an agency problem. Because in such a scenario, customers may well keep the money with themselves, eventually impacting the bank’s business.

Another example can be the management or directors of a company. Again, if they don’t work efficiently and work in a manner that the decisions are taken in their interest, it is an agency problem.

Types of Agency Problem

In an organization, there can be various agency problems amongst different groups, such as:

Types of Agency Problem

1. Management vs Owners

An organization appoints outside professionals who manage and run the company. However, if the management makes decisions that are not in favor of the business, then there can be conflicts between them and the owners, which is nothing but an agency problem.

2. Customer vs Owners

Yes. They can be conflicts between customers and owners as well. For example, say the company decides to increase the product’s price; in such a case, the customer may not buy the product and may shift towards other competitors’ products.

3. Senior vs Junior

In any organization, various people are employed who look after the company’s overall management. Usually, people at a higher managerial level take decisions or draft the steps to be taken and followed by all. There is a high possibility that people at lower or base levels may have a conflict here.

4. Employees vs Owners

Employees may want a better raise or incentive, and if the company does not adhere to the same, there may be a conflict between employees and owners or management.

5. Creditors vs Owners

Here, the problem can arise when the owners may make confident decisions that entail a high risk to earn higher rewards. The owners will have to fetch more loans for big or risky projects. And say in a turnaround event of them incurring losses in the project or the project failing to achieve the desired profitability, the creditors will lose money, and thus in such a situation, conflicts may arise between creditors and owners.

Reasons Behind Agency Problem

An agency problem occurs when there is a conflict or disagreement between the agent and principal. An agent is supposed to act in the principal’s best interest and maximize his benefit. A dispute mainly arises when the agent puts his interest ahead of his professional one.

In other words, when an agent makes a commercial decision that is for his benefit and not for the organization/ principal, the agency problem comes into the picture.

Solutions for Agency Problem

To avoid agency problems, one must ensure appropriate incentives to the agent / authorized representatives to compensate them for their efforts.

Following are a few ways in which we can solve it:

  • Hiring ethical managers
  • Getting a financial audit done
  • Performance-based incentives
  • Stock options – ownership of the organization will make them make moral decisions.
  • Recognition/awards for highlighting their achievements
  • Incentives based on results rather than time spent

Impacts of Agency Problem

The presence of agency problems may affect organizations’ interests as the same might be overlooked, thus impacting the business being carried on. In addition, any decision taken by management that is not in the more significant interest of the organization will ultimately have a bearing on stockholders’ wealth. Thus, steps must be taken to ensure that agency problem are reduced as much as possible so that management is motivated to put the interest of the organization and stockholders ahead of its own.

Why is the Agency Problem Important?

The agency problem is essential as it is used to measure the relationship amongst the people involved in running the organization or who have important roles.

It would not be wrong to say that management is considered unethical to exploit the owner’s/stockholders’ interests to feed their benefits.

Management generally comprises professionals hired to look after the business and make decisions for the same. It is always good to keep control and ownership different. However, it comes with its own set of concerns.

Conclusion

To summarize the whole discussion, the agency problem is simply a difference of opinion between the people who help operate and manage the organization and its owners. People who manage the organization, such as management, employees, and lenders, act in the organization’s best interest, ultimately help achieve maximum benefits to its owners, and simultaneously be compensated for it. The concern or problem arises when these people focus on their interests instead of maximizing owners’ wealth. Therefore, although we cannot eliminate the agency problem, as stockholders need professional people to manage the organization, both parties should work on this problem and minimize it to the extent possible.

Recommended Articles

This is a guide to Agency Problem. Here we also discuss the introduction and types of agency problems along with examples. You may also have a look at the following articles to learn more –

  1. Class A Shares
  2. How Does Outsourcing Reduce Cost?
  3. Credit Risk Management
  4. Credit Risk Management
Popular Course in this category
Investment Banking Course (123 Courses, 25+ Projects)
  123 Online Courses |  25 Hands-on Projects |   600+ Hours |  Verifiable Certificate of Completion
4.9
Price

View Course

Related Courses

Mergers & Acquisition Course (with M&A Projects)4.9
Financial Modeling Course (7 Courses, 14 Projects)4.8
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
About Us
  • Blog
  • Who is EDUCBA?
  • Sign Up
  • Live Classes
  • Corporate Training
  • Certificate from Top Institutions
  • Contact Us
  • Verifiable Certificate
  • Reviews
  • Terms and Conditions
  • Privacy Policy
  •  
Apps
  • iPhone & iPad
  • Android
Resources
  • Free Courses
  • Investment Banking Jobs Offer
  • Finance Formula
  • All Tutorials
Certification Courses
  • All Courses
  • Financial Analyst All in One Bundle
  • Investment Banking Training
  • Financial Modeling Course
  • Equity Research Course
  • Private Equity Training Course
  • Business Valuation Course
  • Mergers and Acquisitions Course

ISO 10004:2018 & ISO 9001:2015 Certified

© 2022 - EDUCBA. ALL RIGHTS RESERVED. THE CERTIFICATION NAMES ARE THE TRADEMARKS OF THEIR RESPECTIVE OWNERS.

EDUCBA
Free Financial Modeling Course

3 Statement Model Creation, Revenue Forecasting, Supporting Schedule Building, & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA Login

Forgot Password?

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

Let’s Get Started

By signing up, you agree to our Terms of Use and Privacy Policy.

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Loading . . .
Quiz
Question:

Answer:

Quiz Result
Total QuestionsCorrect AnswersWrong AnswersPercentage

Explore 1000+ varieties of Mock tests View more