Critically discuss the principle-agent problem, and what implications does it have for the firm in the context of financial crisis?
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For any business to be successful it needs to know that its agents are working in the companies interests and not their own, but very often this is not the case and is known as the principle-agent problem. It can occur in any business but mainly in the larger ones, such as multinationals. An unprincipled agent can be a single employee of a company or another company contracted on company’s behalf when they have withhold information from the principle and begin to act on their own looking at their own interests at the expense of the company. (Bishop, 2004) For example, paying themselves large wages and using expensive means of travel, hire cars and aircraft that is not needed for their job. Even falsifying information or accounts to make business to look better than it actually is, perhaps to give their shares at a higher value. It is in the principles interests to make sure contracts are binding and to maximise profits, but in agent’s interests is prestige and luxury that the company cannot afford. The reason for this is that they often employ other agents to run their business. If that agent is not working in the best interests of the company, this will obviously reduce the principal’s profits. In the worst case it can and has been known to cause the collapse of the company all together. (McConnell&Brue,2008) A good example of this is the collapse of the American Insurance Company which was taken down by one of its departments by speculating and buying and selling contracts the failure of which bankrupted the company even if it only accounted for a small percentage of its profits.…
- Critically discuss the principle-agent problem, and what implications does it have for the firm in the context of financial crisis?
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