University Corporate Governance: Principal-Agent Problem Mitigation

This report delves into the core issue of the principal-agent problem within corporate governance, examining the challenges arising from the relationship between organizational shareholders (principals) and hired management (agents). It identifies key issues such as asymmetric information and conflicting interests that can undermine organizational performance. The report analyzes various problems, including differences in interests, lack of transparency, and the impact of incentives. Furthermore, it explores mitigation strategies like contract design and incentivizing mechanisms that can help align the goals of principals and agents, improve communication, and foster a more collaborative environment. The report aims to offer a comprehensive understanding of the principal-agent problem and its potential solutions, thereby enabling businesses to achieve their collective goals effectively.

Running head: CORPORATE GOVERNANCE
CORPORATE GOVERNANCE
Name of the student
Name of the university
Author note

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Introduction
Corporate governance plays an important role in improving the performance of the
organizations. In this connection, the principal-agent relations holds a large contribution to the
effective functioning of the business processes while focusing to achieve the common goals of
the venture (Kostova, Nell and Hoenen 2018). The organizational shareholders or the principals
take the initiative of hiring different agents in the form of agents with specific sets of
professional skills and attributes. The hiring or recruitment policy of the agents are developed by
the principals with the perspective of improving the organizational performance (Bebchuk,
Cohen and Hirst 2017). Therefore, most of the business entrepreneurs, shareholders or the
leaders take the initiative of improving their relation with the agents for experiencing an elevated
business performance. However, there are considerable challenges that might be faced by the
principals while maintaining a healthy relation with the agents and vice versa due to the clashing
interests and the asymmetric information between them.
Therefore, the report aimed at identifying the major issues that are being confronted by
the principals and the agents in their relationship. The report will also focus on discussing the
different mitigation strategies that might be considered by both the parties with the purpose of
resolving the issues between the principals and the agents while enabling the business to
maintain consistency in meeting their collective goals.
Principal-agent problems
Principal- agent relation
The Principals or the shareholders of an organization takes the initiative of hiring skilled
and experienced personnel in the form of Agents with the purpose of managing the different
business level operations. The inclusion of skilled personnel in the business model for efficient

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management of the different operations enables an organization in improving their performance.
According to Roach (2016), the specific skill sets of the agents permits an organization in
specializing on the different activities while focusing on achieving the common goals of the
venture. The shareholders or the Principals specifically aims towards improving the
organizational performance through the inclusion of Agents, who are skilled towards
micromanaging the different operations. On the other hand, De Massis et al. (2018) opined that
most of the shareholders hold little knowledge on managing vast and complex process structures
while identifying the changing market trends. In this relation, the Agents, containing specialist
knowledge on the different departments of operations enables the shareholders in achieving the
common goal of the venture through their continuous support. However, the Principal-Agent
relationship are liable to different challenges which might incapacitate an organization in
achieving the common goals.
The common problems encountered by Principal-Agent relationship
The most noted issue that challenge the sustenance of the Principal- Agent relationship is
the asymmetric knowledge or information between the two groups. The asymmetric knowledge
or inequality of information between the shareholders and the managers or the principals and the
agents might create ambiguities in the business model. According to Grashuis (2019), inequality
of knowledge between the principal and the agents affect the capability of the organizations in
empowering a collaboration between the groups with the perspective of achieving the common
interests of the organization. Moreover, Reuer and Klijn (2018) observed that in most of the
organizations the shareholders take the initiative of upholding the confidentiality of the business
strategies from the managers which might degrade trust and operational malfunctioning. On the
other hand, it has been observed that the agents possess more information and knowledge on the

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processes than the principals which might create a disruption in the overall process and
mismanagement from the side of the principals.
Mitnick (2019) stated that the principals invests on the sustainability and profitability of
the business organizations whereas the agents modify the overall processes with the purpose of
fulfilling their own interests. The asymmetrical knowledge between the principal and the agents
might again affect the capability of the organization in maintaining transparency. Douthit and
Majerczyk (2019) opined in a research that the principals keep confidentiality with the purpose
of retaining their advantageous position over the agents and safeguarding the trade secrets.
However, Hoi, Wu and Zhang (2019) opined that the lack of information transmission to the
agents might affect the capability of the organization in achieving the common goals of the
venture. On the other hand, the specialist knowledge of the agents like managers contributes to
the operational processes of an organization.
However, Reim, Sjödin and Parida (2018) noted in a research study that most of the
agents makes use of the capital investments that are made by the principals for fulfilling their
own interests apart from the common goals of the venture. The lack of transparency in the
information transmission incapacitates the principals of an organization in idealizing the
situation of the organization. According to Oliveira and Fontes Filho (2017), the asymmetric
transmission of information disrupts the overall operational criteria through lack of trust between
the two parties, the Principals and the Agents. The growth of organizations through the
implementation of Agency Functions are specifically reliant on the trust and collaboration
between the principals and the agents. The asymmetric distribution of information among the
parties might affect the level of indulgence and collaboration between both the parties while
focusing to achieve the common goals of the venture. According to Chari et al. (2019), the

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imbalance in transmission of viable information from the side of the agents to the principals
might create a negative impact on the trust and confidence while increasing the redundancy of
the operational processes. Therefore, the improved relation between the parties are specifically
reliant on the ideology of trust, commitment and loyalty. In this connection, the absence of
sufficient information transmission might affect he interests of the either the principals or the
agents.
The differences between the interests of the shareholders and the managers or the
principals and agents respectively might affect the relation between the same. Eugster and Isakov
(2019) stated that the shareholders, or the principals, hold an interest towards increased
profitability of the business with the purpose of gaining better returns on their invested amount.
On the contrary, Bhattacharya and Singh (2019) observed that the managers or the agents have
an increased interest towards maintaining the stability and sustenance of the venture for securing
their jobs on the long term setting. The differences in the interests of the agents and the
principals results to dissatisfaction. The major motives of the shareholders are guided towards
the improvement of the profitability of the organization for experiencing better returns. The
shareholders delegate or assign different responsibilities on the basis of improving the
profitability of the business. In this connection, Li (2019) stated that the short term interests of
the shareholders are involved in the decisions that are being considered by the same.
On the contrary, the agents make their decisions based on the long term sustenance of the
business through their extensive knowledge on management. The major priorities that are
considered by the agents during this decisions are related to the sustenance of their compensation
and job security in the markets. According to Cumming, Johan and Schweizer (2017), the
sustenance of the business assures the agents of their compensation and remuneration related

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aspects and thereby most of the stakeholders or the agents take the initiative of prioritizing the
long term sustenance and growth of the firm. On the other hand, Longo and Giaccone (2017)
opined that the principals, or shareholders, being the owners of the business with maximized
investment delegates or assigns roles with the perspective of maximizing their profitability. The
differences in the interests and priorities between the principals and the agents are one of the
major causes of the agency problem that is being encountered by the organizations.
However, Ashraf, Li and Ryan Jr, (2020) stated that the principals hire the agents with
the purpose of assisting the same in accruing wealth from the venture. However, the disparities
in the interest of the principal and the employees or the agents occur due to lower incentives or
lack of motivation to achieve the goals. It might affect the capability of the organization’s
principals in motivating the agents and operating in accordance with the common goals of the
venture. Politis and Politis (2018) opined that lack of effective incentive planning in most of the
organizations has been a greater cause for disparities among the interests of the principals and
the agents. From a research made by Lee, Oh and Yermack (2017), it has been observed that
poor incentives to the managers and the employees resulted to minimization of the efforts that
the same are expected to provide towards the success of the venture. Again, Douthit and
Majerczyk (2019) opined that the disparity of interests between the principal’s wealth making
priorities and agent’s incentive priorities have led the latter towards operating in a manner which
is discrete from that of the shareholders or the principals. Therefore, the disparity in interests of
both the parties, agents and shareholders, is again an important point to be considered for the
agency problem that is being faced by the organizations.

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Mechanisms for mitigating the issues
The mechanisms that might be considered for resolving the agency problem in the
organizations are being enumerated in this section of the discussion.
 Contract design: Contract design plays an important role in empowering the transmission
of information between the agents and the principals while specifying their
responsibilities. The clarity of the contract design would allow an organization in
avoiding the separation between ownership and control in the interests of the
organizational profitability. According to Oliveira and Fontes Filho (2017), contract
design plays an important role in creating risk aversion towards an agent-principal
conflict based on asymmetric information. The ownership of the organization and control
over the overall operations might be induced by the shareholders by opting for
information transmission where the managers are required to report the whereabouts of
the business to the owners. In this relation, the managers take the initiative of disclosing
every strategic decision that is being planned by the same towards organizational
performance and growth to the owners or the shareholders with the purpose of keeping
the same aware of the strategic direction of the venture. According to Kostova, Nell and
Hoenen (2018), the nature of the contract design permits a principal in gathering
information on the operational processes and thereby control the same. Therefore, it
might be stated that contract designing aspects supports a principal in establishing the
links between the ownership and control related operations of the firm.
 Incentivising: The principals or the shareholders might take the initiative of developing
different incentive bars with the purpose of keeping the workforce and the managers
motivated towards the operations. It has been observed that the differences in the

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priorities and interests of the shareholders and the agents are the major contributor to the
agency problem that is being faced by the organizations. In this connection, the
shareholders are noted to have an inclination towards increasing their wealth. However,
the managers or the employees, working as agents of the shareholders are noted to hold
little interest on wealth creation for the owners, which results to discrete operations.
According to Hoi, Wu and Zhang (2019), incentives acts as an inclusionary measure on
behalf of the shareholders while increasing the rate of operations of the agents as per the
common goals of wealth creation. For an example, the development of incentive schemes
based on performance audits would allow the shareholders or the business owners in
empowering the activities of the agents, on financial terms. Moreover, providing
incentives based on stock options, profit-sharing, and deferred compensation would allow
the shareholders in improving relation with the agents. The proposition of the incentives
would allow the shareholders in maximizing the involvement of the agents in the wealth
creation related operations. The inclusion of the agents in the wealth creation related
activities of the venture will be critically supported through profit-sharing and deferred
compensation. Steady incentivising on the different operations would allow the business
owners in improving the rate of business operations while motivating the agents to
perform towards the common goal. Therefore, the provisions for incentivising the
operations are essential for empowering engagement of the agents in the wealth creation
related priorities of the shareholders or the owners.
Conclusion
Therefore, from the above analysis it has been observed that agency problems in the
organizations are specifically triggered through the asymmetrical information between the

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principals and the agents along with a clash of interests which is detrimental to organizational
wellbeing. The principals being the shareholders or owners prioritize wealth creation and
profitability which is however disregarded by the agents as they hold little interest on the profits.
The clash of interests and the breach between ownership and control are the major reasons for
the exposition of the agency problem in organizations. In this connection, the research critically
examined the issues relating to the agency problem in organizations and thereby suggested the
control mechanisms for avoiding such situations, disrupting organizational sustenance.

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References
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