Agency Problem
Candlefocus EditorSimply put, an agency problem happens when someone (the “agent”) acts on behalf of another person or entity (the “principal”). The problem arises when the agent makes decisions that are not in the principal’s best interests. This can be because the agent has his or her own interests in mind and believes that they will be better served by making decisions that benefit him or herself, or because the agent has incentives to make decisions that don’t benefit the principal.
For instance, an agency problem would arise if an executive at a company makes decisions that will benefit him or her financially instead of the company’s shareholders. Such behavior is a direct violation of the executive’s fiduciary duty to act in the best interest of the corporation and its shareholders.
Agency problems are also a concern for investors. Investors should be aware of how their assets are being managed and whether or not the assets are managed in their best interest. If an investor’s financial advisor is making decisions for the investor without taking into account all the risks involved, this could lead to an agency problem.
To prevent agency problems, many regulations and oversight structures have been put in place. Regulations like Sarbanes-Oxley give investors more insight into how their assets are being managed. Incentives can also be put in place to encourage agents to act in the best interests of the principal. For instance, executive compensation structures can be changed so that executives will be rewarded for making decisions in the best interests of the corporation.
The agency problem remains a challenge for individuals, corporations and investors alike. However, with proper oversight and incentives, the problem can be minimized. By understanding the agency problem and taking steps to prevent it, investors can ensure that their assets are managed in their best interests.