Question

Explain how agency conflicts arise in an organization. What are the appropriate solutions to reduce agency costs? Cite appropriate examples from Saudi Firms. 

Answer 1

Agent is an person who carries out the business activities on behalf of another person or business. The main business is the principal and the other party who carries out the business' activities is the agent. There are many situations where the principal and the agent have conflicts among themselves. There can be several reasons for agency conflicts. One such reason is the incongruity of the agent's and principal's goals with each other. Since the agent is working on behalf of the principal so it is expected that the agent's goals will be the same as the principal's goals. But there might be some situations where the agent's goals may not match with that of the principal. This leads to agency conflicts.

Agency cost arises on the expenditure that the agent incurs while carrying out the business activities on behalf of the principal. These costs include the agent's fee and other expenditure like travel, conveyance etc. The agency costs increase when there is no proper communication between the agent and the principal. The conflicts between the two parties will lead to increase in the agency cost. So to reduce the agency cost, there has to be a clear cut contract or agreement between the agent and the principal regarding the fees and other fees. This will make the terms and conditions clear between the two parties and the chances of conflict will be reduced.

In Saudi firms, the agency costs are being reduced by implementing voluntary disclosure and transparency from the companies.