Conflicts of Interest, Agency Problems, and Their Impacts on the Firm

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Agency Theories

To establish a framework for analyzing potential agency problems, it is important, to first identify theoretical constructs surrounding the firm.  In the context of agency, Fama (1980) suggests, that management-agents and risk-bearing principals utilize a nexus of contracts.  That is, management carries out various contractual responsibilities through coordinating in put activities through managerial decision making (Fama, 1980).  On the other hand, principals contract to undertake varying degrees of risk to finance the activities of management and the organization (Fama, 1980).  The resultant outcomes of these factors of production create a contract based firm consisting of agents and principals endeavoring to create value for the firm (Fama, 1980).  Closely aligned to agency theory, is Milton Friedman’s supposition implying that the primary concern of the contractual based firm is to increase shareholder profits (MacAleer, 2003).

A third theoretical perspective regarding agency problems might be found in stakeholder theory.  Contemporary stakeholder theory is often grounded in Freemans Strategic Management: A Stakeholder Approach (1984).  Here, stakeholders are identified as individuals or groups holding an interest in a firm’s activities or those impacted by the firm (Freeman, 1984).  These stakeholders are often identified as primary stakeholders having prescribed roles in a firm, having authoritative responsibilities in a firm, or those with contractual relationships to a firm, and secondary stakeholders include all other individuals, groups, or societal parties impacted by the firm and its outputs (Freeman, 1984).  A foundational component of stakeholder theory, intimates that, the role of the management-agent is to attain balance between the concerns of all stakeholders (Shankman, 1999).  One might posit, that stakeholder theory expands the firm based contractual construct in a manner that engages both primary and secondary stakeholders (Shankman, 1999; Rose, 2004).

Examples of Potential Agency Problems

In September of 2016, the United States (U.S.) Department of Justice (DOJ)indicated that Deutsche Bank (DB) would be subject to a $14 billion fine for its role in propagating mortgage backed securities products linked to the 2007-2010 era global financial crisis (Valentini, 2016).  Some suggest, that managers and executives at DB failed to fulfill their firm based, others might argue societal based, contractual agreements supporting shareholder value (Valentini, 2016; Freeman 1984; Shankman, 1999).

In September of 2015, the U.S. Environmental Protection Agency (EPA) announced that Volkswagen (VW) engineers installed illegal software in its diesel engines capable of overriding emissions monitoring systems (Tuttle, 2015).  In December 2015, VW admitted that firm had installed emissions monitoring defeat devices in U.S. diesel vehicles (Tuttle, 2015).  The EPA estimates these devices resulted in emissions 40 times the allowable rate to be released into the atmosphere (Tuttle, 2015).  Two days following the September 2015 announcement VW stock plummeted 55% resulting in a loss $55 billion in market value (Tuttle, 2015).

In these aforementioned cases involving potential agency problems, one might find, various and differing conflicts of interest among the actors of these firms.  For example, engineers at VW concocting felonious software to dupe regulators, or executive managers at DB proliferating credit default swap vehicles that subjected shareholder investments to out-sized risk (Valentini, 2016; Tuttle, 2015).

Proponents of classic agency theory might suggest goal conflicts surrounding the divergence of management-agent decision making from the interests of principals (Shapiro, 2005).  Agency theory adherents, often infer, that agency problems involve goal conflicts impacting Friedman’s intimation, that the central role in agency relationships is in achieving the economic paramount of expanding profit (MacAleer, 2003; Shankman, 1999).  For example, poor incentives that diminish agent engagement and congruence with principal party interests, might entice agents to devise opportunities to improve their personal position (Shapiro, 2005).

Conversely, theorist aligned with firm based stakeholder principles consider the notion that managerial agents are often inundated with conflicting interests among both internal and external competing forces (Shankman, 1999; Shapiro, 2005).  Despite theoretical approaches, each of these architypes, might agree the agency problem exists and the impacts on the firm are manifold (Shapiro, 2005).  Agency problems involving each of these examples might include potential impacts to wealth of principal investors and the investments of holders of the firms’ securities.  Further, societal impacts might include the potential for monies in the form of taxes to bail out the companies, were they to falter, the potential for job losses predicated on the firms weakened financial positions, and in the case of VW, environmental impacts with potentials to affect the health and well-being of societal members.  Thus, exists the potential for impacts to multiple stakeholders including agents, principals, employees, and society (Tuttle, 2015; Valentini, 2016).

Congruence on Agency Problem Primacy

This writer suggests, that to support the position of the primacy of agency problems one might identify common ground between competing theoretical views. Further, this position might be augmented if these views can be harmonized in a manner that combines these competing theories in a supportive methodology.  To that end, the author submits, that Friedman’s position of the firm’s existence as an economic engine, classic agency views supporting the management-agent to principal contract, and stakeholder views combined provide a self-propagating contractual system.

Consider, that in order to continue growing as an economic engine stakeholder management agents must provide returns, economic and otherwise, across stakeholder types including, employees, shareholder-principals, and society (Shankman, 1999; MacAleer, 2003).  In other words, the interests of all stakeholders contain intrinsic value to the agency (Shankman, 1999).  Further, agency intrinsic value across stakeholder groups is manifest through implicit societal contracts with firms (Shankman, 1999).  These contracts provide the grounds, some might add liberty, upon which the firm operates as an economic engine endeavoring to create wealth for principals, while at the same time, they allow the firm to fulfill its contracts with principals, stakeholders, and society (MacAleer, 2003; Shankman, 1999; Shapiro, 2005).  On these ground, the author submits, that conflict of interest problems interfering with the agencies operations impact the most fundamental component of the agency, its liberty granted through contracts, both internal and external, to operate as an economic engine (Fama, 1980; Freeman, 1984; MacAleer, 2003; Shankman, 1999).

References

Fama, E. F. (1980). Agency Problems and the Theory of the Firm. Journal of Political Economy, 88(2), 288–307.

Freeman, R.E. (1984). Strategic Management: A stakeholder approach. Boston, Ma: Pitman.

Keown, A. J., Martin, J. D., & Petty, J. W. (2014). Foundations of finance: The logic and practice of financial management (8th ed.). Upper Saddle River, NJ: Prentice Hall.

McAleer, S. (2003). Friedman’s Stockholder Theory of Corporate Moral Responsibility. Teaching Business Ethics, 7(4), 437–451.

Shankman, N. A. (1999). Reframing the debate between agency and stakeholder theories of the firm. Journal of Business Ethics, 19(4), 319–334.

Shapiro, S. P. (2005). Agency Theory. Annual Review of Sociology, 31, 263–284.

Tuttle, H. (2015). Volkswagen Rocked by Emissions Fraud Scandal. Risk Management, 62(10), 4,6-7.

Valentini, F. B. (2016, October 5). French Lawmakers Say Deutsche Bank U.S. Fine Could Cause Crisis. Bloomberg.com. Retrieved from http://www.bloomberg.com/news/articles/2016-10-05/french-lawmakers-say-deutsche-bank-u-s-fine-could-cause-crisis

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