8.5 Agency Problems #Notebook

 8.5 Agency Problems

The principal-agent problem is an important subcategory of moral hazard that involves postcontractual asymmetric information of a specific type. 

The principal-agent problem arises when any of those agents do not act in the best interest of the principal.

For example, when employees or managers steal, slack off, act rudely toward customers, or otherwise cheat the company’s owners. 

Another, often more powerful way of reducing agency problems is to try to align the incentives of employees with those of owners by paying efficiency wages, commissions, bonuses, stock options. 

Why investment banker J. P. Morgan used to put “his people” on the boards of companies in which Morgan had large stakes? It's s similar approach has long been used by Warren Buffett’s Berkshire Hathaway. Venture capital firms also insist on taking some management control and have the added advantage that the equity of startup firms does not, indeed cannot, trade.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.