Agency Problem

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What is the 'Agency Problem'

A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The problem is that the agent who is supposed to make the decisions that would best serve the principal is naturally motivated by self-interest, and the agent's own best interests may differ from the principal's best interests. The agency problem is also known as the "principal–agent problem."

BREAKING DOWN 'Agency Problem'

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. However, it is in the manager's own best interest to maximize his own wealth. While it is not possible to eliminate the agency problem completely, the 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 and the threat of takeovers.

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RELATED FAQS
  1. What is the role of agency theory in corporate governance?

    Understand how businesses use agency theory in corporate governance. Learn how moral hazard problems may be addressed using ... Read Answer >>
  2. How does agency theory propose to deal with the agency problem?

    Learn more about agency theory and how businesses may use it to understand employee-employer relations. Find out more about ... Read Answer >>
  3. How do stockholders use agency theory to affect management?

    Explore the intricacies of agency theory that places stockholders and management in a unique relationship where both parties ... Read Answer >>
  4. Do employers use agency theory in labor relations?

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  5. Does agency theory apply to brokers and clients?

    Learn how the existence of incentives that encourage moral hazard impacts broker-client relationships. Understand how agency ... Read Answer >>
  6. What are some famous scandals that demonstrate the agency problem?

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