Assignments On Agency Problem and Strategies For Mitigating It BY Adnan Hussain

ASSIGNMENTS ON AGENCY PROBLEM AND STRATEGIES FOR
MITIGATING IT
BY
Adnan Hussain
An assignment submitted to the IBMS, agriculture university Peshawar in partial fulfillment of

the requirements for the current semester.
Program
Bachelor of business administration
(IBMS)
INSTITUTE OF BUSINESS MANAGEMENT SCIENCES

FACULTY BUSINESS AND ECONOMICS
THE UNIVERSITY OF AGRICULTURE, PESHAWAR
KHYBER PAKHTUNKHWA-PAKISTAN
29, June 2020

Agency Problem
The agency problem is a conflict of interest inherent in any relationship where one party is
expected to act in another's best interests. In corporate finance, the agency problem usually refers
to a conflict of interest between a company's management and the company's stockholders. The
manager, acting as the agent for the shareholders, or principals, is supposed to make decisions
that will maximize shareholder wealth even though it is in the manager’s best interest to
maximize his own wealth. The agency problem does not exist without a relationship between
a principal and an agent. In this situation, the agent performs a task on behalf of the principal.
Agents are commonly engaged by principals due to different skill levels, different employment
positions or restrictions on time and access. For example, a principal will hire a plumber—the
agent—to fix plumbing issues. Although the plumber ‘s best interest is to collect as much income
as possible, he is given the responsibility to perform in whatever situation results in the most
benefit to the principal. The agency problem arises due to an issue with incentives and the
presence of discretion in task completion. An agent may be motivated to act in a manner that is
not favorable for the principal if the agent is presented with an incentive to act in this way. For
example, in the plumbing example, the plumber may make three times as much money by
recommending a service the agent does not need. An incentive (three times the pay) is present,
causing the agency problem to arise. Agency problems are common in fiduciary relationships,
such as between trustees and beneficiaries; board members and shareholders; and lawyers and
clients. A fiduciary is an agent that acts in the principal's or client's best interest. These
relationships can be stringent in a legal sense, as is the case in the relationship between lawyers
and their clients due to the U.S. Supreme Court's assertion that an attorney must act in complete
fairness, loyalty, and fidelity to their clients.
Strategies for Mitigation of Agency Problems
Agency costs are a type of internal cost that a principal may incur as a result of the agency
problem. They include the costs of any inefficiencies that may arise from employing an agent to
take on a task, along with the costs associated with managing the principal-agent relationship and
resolving differing priorities. While it is not possible to eliminate the agency problem, principals
can take steps to minimize the risk of agency costs.
Regulations
Principal-agent relationships can be regulated, and often are, by contracts, or laws in the case of
fiduciary settings. The Fiduciary Rule is an example of an attempt to regulate the arising agency
problem in the relationship between financial advisors and their clients. The term fiduciary in the
investment advisory world means that financial and retirement advisors are to act in the best
interests of their clients. In other words, advisors are to put their clients' interests above their
own. The goal is to protect investors from advisors who are concealing any potential conflict of
interest. For example, an advisor might have several investment funds that are available to offer
a client, but instead only offers the ones that pay the advisor a commission for the sale. The
conflict of interest is an agency problem whereby the financial incentive offered by the
investment fund prevents the advisor from working on behalf of the client's best interest.
Incentives
The agency problem may also be minimized by incentivizing an agent to act in better accordance
with the principal's best interests. For example, a manager can be motivated to act in the
shareholders' best interests through incentives such as performance-based compensation, direct
influence by shareholders, the threat of firing or the threat of takeovers. Principals who are
shareholders can also tie CEO compensation directly to stock price performance. If a CEO was
worried that a potential takeover would result in being fired, the CEO might try to prevent the
takeover, which would be an agency problem. However, if the CEO was compensated based on
stock price performance, the CEO would be incentivized to complete the takeover. Stock prices
of the target companies typically rise as a result of an acquisition. Through proper incentives,
both the shareholders' and the CEO's interests would be aligned and benefit from the rise in stock
price.
Principals can also alter the structure of an agent's compensation. If, for example, an agent is
paid not on an hourly basis but by the completion of a project, there is less incentive to not act in
the principal’s best interest. In addition, performance feedback and independent evaluations hold
the agent accountable for their decisions.

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ASSIGNMENTS ON AGENCY PROBLEM AND STRATEGIES FOR

An assignment submitted to the IBMS, agriculture university Peshawar in partial fulfillment of

Bachelor of business administration

INSTITUTE OF BUSINESS MANAGEMENT SCIENCES

29, June 2020

Strategies for Mitigation of Agency Problems

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