Question

In one to two paragraphs.

Explain Agency Theory. Give two real examples of where the agent works against the interest of the company. How could governance help protect the company? Why did it not work well.

Answer 1

The Agency Theory proposed compensation in the form of stock or stock options as a solution for the potential problem of senior managers acting in their own self- interests, not in the interests of owners. The agency problem is the problem which arises between principals (Stakeholders) and agents (managers) due to conflict of interest between them. Generally the company belongs to its stakeholder and they are interested in value/profit maximization of the company. The stakeholders hire managers (agents) to operate the company based on stated mission and vision of the company and managers get fixed salary for their services. Although the primary responsibility of managers are taking best care of company’s interest but some time they take advantage of their position and first look to their own interest even if it is harming company’s interest.

The two real examples of the agency problem is collapse of Enron and WorldCom; where top officials (agents) worked against the interest of the company.

Governance help protect the company but the damage was too severe so it did not work well. Some regulations came in response to adverse business events like the Sarbanes-Oxley Act was passed in early 2000s.These events had disappointed the investors’ and reduced their confidence so this act was necessary to rebuild the investor’s confidence in the market.