Principal-Agency Relationships in Business Environment

Agency relations take place in situations when one person or a group of people (principals) instructs another person or a group of people (agents) to perform certain actions on behalf of the principal, which is accompanied by the transfer of decision-making power from the principal to the agent. With regard to corporate governance, the agency problem describes the situation of the multidirectional interests of the owners and top managers of the company.

In the case when the structure of the manager’s remuneration includes a variable part in the form of shares or stock options, the management has an additional incentive to work for the growth of the company’s share price, which is beneficial to its owners. Apple is a company that directly follows this principle to address the principal-agent issue. Then, in a concentrated ownership structure, where there is a large majority shareholder, the manager is more likely to behave appropriately since it is easier for the majority shareholder to monitor and internalize the benefits of doing so.

The successful case here comes from Google, which retains a large percentage of ownership to deal with the mentioned problem. Finally, competition in the labor market and the threat of dismissal by shareholders or the board of directors can also force management to avoid opportunistic behavior since reputation is important for the manager, and especially for the CEO, when hiring. An example here is IKEA, which decided to provide as many managerial positions as possible.

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