Chapter 2: The Agency Problem
Two general functions of the corporate law:
establishes the structure of the corporate form
attempts to control conflicts of interests among corporate constituencies, including those between
“insiders” (controlling shareholders and top manager) and “outsiders” (minority shareholders and
creditors).
Agency problems: arises whenever the welfare of one party (the principal) depends upon actions taken by
another party (the agent); The problem lies in motivating the agent to act in the principal’s interest rather
than simply in the agent’s own interest.
The core difficulty is that because the agent commonly has better information than those the principal
about the relevant facts, the principal cannot easily assure himself that the agent’s performance is precisely
what was promised. Consequently the agent has an incentive to act opportunistically. To assure the quality
of the agent’s performance, the principal must engage in costly monitoring of the agent → reduce the value
of the agent performance to the principal.
Three are the main agency problems in business firms:
1. The conflicts between the firm’s owner (principal) and it’s hired managers (agent); the problem is if
the managers are responsive to the owners interests.
2. conflicts between the majority shareholders (agent) with the minority shareholder (principal);
3. conflicts between the firm (agent) itself and the non shareholders (creditors, employees and
customers); avoid the opportunistic behaviour over the non-shareholders.
■ Legal strategies for reducing agency costs
Legal strategies can be divided in two subset:
Regulatory strategies: are prescriptive; they dictate substantive terms that govern the content of
the principal-agent relationship, tending to constrain the agent’s behavior directly. the efficacy
depend on the ability of an external authority (court) to determine whether the agent complied
with particular prescription.
Governance strategies: seek to facilitate the principal control over the agent’s behavior; the
efficacy depends crucially on the ability of the principals to exercise the control rights accorded to
them. Require only that the principals themselves are able to observes the action taken by the
agent, for which purpose “softer” information may suffice.
Two general functions of the corporate law:
establishes the structure of the corporate form
attempts to control conflicts of interests among corporate constituencies, including those between
“insiders” (controlling shareholders and top manager) and “outsiders” (minority shareholders and
creditors).
Agency problems: arises whenever the welfare of one party (the principal) depends upon actions taken by
another party (the agent); The problem lies in motivating the agent to act in the principal’s interest rather
than simply in the agent’s own interest.
The core difficulty is that because the agent commonly has better information than those the principal
about the relevant facts, the principal cannot easily assure himself that the agent’s performance is precisely
what was promised. Consequently the agent has an incentive to act opportunistically. To assure the quality
of the agent’s performance, the principal must engage in costly monitoring of the agent → reduce the value
of the agent performance to the principal.
Three are the main agency problems in business firms:
1. The conflicts between the firm’s owner (principal) and it’s hired managers (agent); the problem is if
the managers are responsive to the owners interests.
2. conflicts between the majority shareholders (agent) with the minority shareholder (principal);
3. conflicts between the firm (agent) itself and the non shareholders (creditors, employees and
customers); avoid the opportunistic behaviour over the non-shareholders.
■ Legal strategies for reducing agency costs
Legal strategies can be divided in two subset:
Regulatory strategies: are prescriptive; they dictate substantive terms that govern the content of
the principal-agent relationship, tending to constrain the agent’s behavior directly. the efficacy
depend on the ability of an external authority (court) to determine whether the agent complied
with particular prescription.
Governance strategies: seek to facilitate the principal control over the agent’s behavior; the
efficacy depends crucially on the ability of the principals to exercise the control rights accorded to
them. Require only that the principals themselves are able to observes the action taken by the
agent, for which purpose “softer” information may suffice.
