The “agency problem” occurs when there is a separation of ownership and control in a business. This separation can create a conflict of interests between the owners (also known as the “principal”) and the agents (such as the management team) hired to run the business on behalf of the owners.
The principal-agent relationship is common in many different types of businesses, but it is particularly relevant in the context of publicly traded companies, where the owners (i.e., the shareholders) are often not involved in the day-to-day operations of the company. In these cases, the shareholders hire a team of executives (i.e., the agents) to manage the company on their behalf.
The agency problem arises when the interests of the agents and the principal are not aligned. For example, the agents may be more concerned with maximizing their own salaries and perks than with maximizing the value of the company for the shareholders. This can lead to mismanagement, waste, and even fraud, as the agents pursue their own interests rather than those of the principal.
To address the agency problem, businesses often use a variety of mechanisms to align the interests of the agents with those of the principal. These mechanisms can include performance-based compensation, oversight by independent directors, and shareholder voting rights. By using these and other tools, businesses can help to ensure that the agents are acting in the best interests of the principal, rather than just pursuing their own interests