Agency Theory in the Light of Management

¶ … agency theory in the light of management conflict with shareholders and issues pertaining to compensation packages for executives. It has 10 sources.

Management role as agency and their relationship with shareholders often result in conflict of interest where executive compensation is concerned. While on the one hand management is keen on developing the company through its qualified CEOs, shareholders are more interested in their returns. As a result there exist problems of differential of interests where investment cash flows, financial management and reporting are concerned. These mechanisms are considered to be the lifeblood of an organization yet have often been subjected to agency issues.

Discussion

According to Osborne and Rubinstein, [1994] the game theory incorporates the spirit of trust between two decision makers. In a situation of agency problem propagation, the two entities involved in decision making mechanism are the stockholders and the managers. The level of agreement of sharing the decision making capabilities by each entity is differential from situation to situation. This level of abstraction ensures coverage of a range of dimensions of decision-making, based on a mutual understanding.

While studying an agency problem such as management and stakeholder relationship / communication gap, there is an urgency to view the game theory in the light of the agency theory. For example if this void in communication/relationship is encouraged can favor managers into pursuit of risk and return of their own priorities, as per the spirit of the agency theory [Lecture Notes, 2003c]. The author suggests that management needs to be monitored in order to minimize the personalization of responsibilities, in favor of individual interest instead of the corporate or shareholder interests. The difference in communication and relationships is attributed to the difference of goals of the managers and stakeholders [Lecture Notes, 2003d].

As identification of a problem logically leads to the solution of it, the (agency) theory hosts a resolution for this dilemma that exists between management and stakeholders. A way to minimize the conflict is highlighted by [Lecture Notes, 2003b] emphasizing on the importance of minimizing conflicts using contractual incentives offered to the management. This may include offering the management the "stock option." Other authors [Lecture Notes, 2003d] suggest financial reporting as one solid means of monitoring (and encouraging) solution towards the agency problems.

Yet despite this fact one observe that agency problem arise out of management's effort to sustain without having to sacrifice their profits to the shareholders in the form of dividend. Understating profits and overstating expenses can lead financial surplus in favor of management. This becomes the cause of discrepancy of figures when consistent infringement is carried out by the role of management. It is considerable to understand the harmful implications of debarring shareholders from the financial reporting of a firm. The firm is the one that suffers the implications in this case related to financial reporting. The act of management may also be responsible for discouraging the shareowners from investment in the future.

Findings

According to [Hallows, 1998], the study of the financials of Colgate-Palmolive revealed that the CEO for the company had earned a stock option worth 2 million dollars adding to the salary and bonuses. Upon further investigation and comparison it was found that the financial revenue of the CEO for Colgate-Palmolive had actually declined in comparison to the other companies. This establishes the fact that most companies have set high compensations for CEO's yet do not in effect perform as marginally as the shareholders expect them to.

Karen Hallows, [1998] mentions an investigation conducted in 383 companies to evaluate the conduct of a CEO governing each of those organizations through a time span of four years. The investigation brought out surprising facts that the annual rate of return measured up to be around 19.2% for those companies, while the CEO of these companies enjoyed an inclined rate in the wage by 38.1%, nearly double the annual rate of return of the company. This establishes that CEO's setup higher wage rates in their own interest against the objectives of the company and the shareholders.

It has been speculated that managers concerned are (supposed to be) aligned with the value of the organization. At the same time, the author discusses that managers enjoy maximum benefits at the company's expense, and are not liable to risks involved in investment. [Lecture Notes 2003a]. This establishes that manager's attitudes can be insensitive towards stockholder's investment.

Arguments exist against providing the management with compensation as it is believed that the compensation entitles the management to greater financial gain, introducing a great inconsistency in the organizational wage equality. [Jensen and Murphy 1994] argue otherwise. The authors believe that the wages for management has declined over a period of times when compared to that in the 1930s yet their compensations have been on the rise constantly to the extent of being considered exorbitant by the investors.

Conclusion

The Game theory identifies the relationship problem existing between the managers and owners of a firm are at an abstract level. The agency theory takes to reduce the level of abstraction by defining the relationship and politics involved in each of these roles. The nature of these entities are revealed by the agency theory showing a tendency to maximize the own utility. Understanding the core natures of the entities help realize the reason for the problem.