<What do you call someone who gets paid not to work?
A shareholder.>
Going beyond the joke above (seen from management and / or board perspective), there is a clear fiduciary duty for the management and the board. The shareholders are the owners of the companies, and the board and the management are appointed by shareholders. In addition, for institutional shareholders are more and more reporting requirements on how they implement stewardship principles and how they engage with portfolio companies.
What is the ‘agency problem’?
The ‘agency problem’ is a complicated situation when sustainable governance is in danger because the interests of a principal and an agent are not in alignment. The name of this situation is the agency problem or principal-agent problem. In case of listed companies, the principal is represented by shareholders and the agent by the management or by the board.
Examples of agency problem
A classic example of misalignment between the manager and the shareholders can be a long-term focus on the part of certain shareholders versus short-term focus on the part of managers and / or the board, caused by an improper designed remuneration system. Agency problem is more typical for large, listed companies especially because of the diverse shareholder structure.
Other example is when a client needs to hire a lawyer and it may worry that the lawyer will add more billable hours than are necessary (for instance for studying) or a client interested to buy an apartment and he may suspect that the intermediary is more interested in a commission than in the buyer's concerns related to the apartment. In the examples presented the principal has little choice in the matter and the agent needs to get the job done, at a good fee. But good fee for agent or for principal?
Potential cures
The primary cause of the agency problem is costs. If the cause is identified the cure is easy. All problems have a solution:
- The agent needs to align to principal will and adapt its interests with the interests of principal: the management and/or the board may adapt to shareholders’ interests (the other way around its difficult because is difficult to oblige shareholders, as they have the power in the end)
- Compensation is always a motivating factor and a high priority for an agent (the management and / or the board). Linking compensation to certain criteria, such as a long-term performance evaluation as profit, non-financial key performance indicators linked with sustainability factors, based on international practice. For listed companies methods of agent compensation should include stock options, and deferred-compensation plans, to encourage management and the board to act as shareholders, not as agents.
- In worst case scenario, the agent is fired. This may be a good opportunity for principal to select other agent, with a better fee, but this brings other risks. The handover period for transferring activities from one agent to another may be a nightmare for all parties involved (old and new management, old and new board and shareholders).