05/07/2022
What Is the Agency Problem?
In general, an agency problem in finance usually happens when an agency (the management of a financial company) does not work in the best interests of the stockholders, (the investors).
You see, because management is hired as the agent for stockholders, it's supposed to make decisions that will benefit stockholders, which in most cases is to maximize the stockholders' wealth. However, when a manager decides to work in his own best interest instead, an agency problem occurs. Sometimes this happens when the agency, or management, encounters costs or a conflict of interest. The agency might then ignore what is best for the stockholders and do what is best for the agency instead.
Like most working individuals, managers want to maximize their own wealth, but this causes conflict between managers and stockholders. So, in order to minimize these types of conflicts, often times, managers are encouraged to work in the best interest of stockholders via incentives. Incentives can be in the form of money, threats of being fired, or by direct influence of stockholders themselves, which can be anything from hiring their own managers to becoming directly involved.
The agency problem describes conflict between the actions of management and the interests of investors. Examine this concept in detail through the...