1. Agency Problem
  2. Understanding Agency Problems
  3. Minimizing Risk with the Agency Problem 

Agency Problem

  • An agency problem is a conflict of interest essential in any relationship where one party is anticipated to act in the stylish interest of another. 
  • Agency problems arise when impulses or provocations present themselves to an agent to not act in the full stylish interest of a Principal. 
  • Through regulations or by incentivizing an agent to act in agreement with the Principal’s stylish interests, agency problems can be reduced. 

Understanding Agency Problems

The agency problem doesn’t live without a relationship between a Principal and an agent. In this situation, the agent performs a task on behalf of the Principal. Agents are generally engaged by headliners due to different skill situations, different employment positions, or restrictions on time and access. For illustration, a Principal will hire a plumber, the agent to fix plumbing issues. Although the plumber ‘s stylish interest is to collect as important income as possible, they’re given the responsibility to perform in whatever situation results in the most benefit to the Principal.  The agency problem arises due to an issue with impulses and the presence of discretion in task completion. An agent may be motivated to act in a manner that isn’t favourable for the Principal if the agent is presented with an incitement to act in this way. For illustration, in the plumbing illustration, the plumber may make three times as important a plutocrat by recommending a service the agent doesn’t need. An incitement (three times the pay) is present, causing the agency problem to arise.  

Minimizing Risk with the Agency Problem 

Agency costs are a type of internal cost that a Principal may dodge as a result of the agency problem. They include the costs of any inefficiencies that may arise from employing an agent to take on a task, along with the costs associated with managing the Principal- agent relationship and resolving differing precedence’s. While it isn’t possible to exclude the agency problem, headliners can take a way to minimize the threat of agency costs.


Principal-agent connections can be regulated, and frequently are, by contracts, or laws in the case of fiduciary settings. The Fiduciary Rule is an illustration of an attempt to regulate the arising agency problem in the relationship between fiscal counsels and their guests. The term fiduciary in the investment premonitory world means that fiscal and withdrawal counsels are to act in the stylish interests of their guests. In other words, counsellors are to put their guests’ interests above their own. The thing is to cover investors from counsels who are concealing any implicit conflict of interest.  For illustration, a counsel might have several investment finances that are available to offer a customer, but rather only offers the bones that pay the counsel a commission for the trade. The conflict of interest is an agency problem whereby the fiscal incitement offered by the investment fund prevents the counsel from working on behalf of the customer’s stylish interest. 


The agency problem may also be minimized by incentivizing an agent to act in better agreement with the Principal’s stylish interests. For illustration, a director can be motivated to act in the shareholders’ stylish interests through impulses similar to performance-grounded compensation, direct influence by shareholders, the trouble of blasting, or the trouble of appropriations.  Headliners who are shareholders can also tie CEO compensation directly to stock price performance. However, the CEO might try to help the pre-emption, which would be an agency problem, If a CEO was bothered that an implicit pre-emption would affect in being fired. still, if the CEO was compensated grounded on stock price performance, the CEO would be incentivized to complete the pre-emption. Stock prices of the target companies generally rise as a result of an accession. Through proper impulses, both the shareholders and the CEO’s interests would be aligned and benefit from the rise in stock price.

Headliners can also alter the structure of an agent’s compensation. However, for illustration, an agent is paid not on an hourly base but by the completion of a design, If. In addition, performance feedback and independent evaluations hold the agent responsible for their opinions.