WEEK 7 AGENCY THEORY AND CORPORATE GOVERNANCE

• Principal Agent Problem • Moral Hazard

Shareholders are unable to constrain corporate managers to act on behalf of the shareholders interests. Instead, managers are acting on their own self interest. In a principal agent problem, there is a separation of ownership and control. Most likely results in a conflict of interest between the principal, owner, and the agent, who controls the activity. Moral hazard or hidden action is information between absentee shareholders and management that opportunistic executives can take advantage of.

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CASE STUDY

• Who is Daniel • Issue Raised • Her Argument • Daniel’s Position

Daniel is one of the founding scientists who is now the director of product development. A new board member has raised the issue of instituting an incentive for management that is solely tied to the firm’s market performance. She states that the package will help the firm be competitive in the market for managerial talent in the biotechnology industry. Daniel believes the firm has made it this far without a program of this nature and will be fine without it. He states the firm deals with products that are related to public health/safety and should be the the leading priority. Daniel feels that human benefits of the firm's activities should be the focus and profits will follow. He does want to keep a culture that makes it important to focus on the firms past competitive advantage, which is developing innovative products.

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Public

QUESTIONS

• What's at stake for the key parties including those with whom Daniel disagrees?

• What are the main arguments Daniel is trying to counter? • What arguments can Daniel use to influence those who

disagree with him? • What is Daniel’s most powerful and persuasive response to

the reasons he needs to address?

There could be issues once people find out that there was a board member who wanted to implement an incentive program for managers based on market performance. Not implementing the program could decrease morale for managers as people could have made more money and would have encouraged others to work harder. People under managers may not be as happy and work as hard once they find out the incentive program was brought up only for managers. Daniel makes a good argument that what has gotten the firm to the current status is what can continue to carry it forward. Other managers and board members will most likely agree with that as it has worked for years, and the company would not have to pay out additional money. Not implementing the program could also limit the new talent that would like to hire into the firm and cause others to leave. Many people, now a days, look for companies that offer incentives and bonuses based on company or individual performance.

Daniel is trying to defend the statement made by the board member that the incentive program would only be tied to the firm's market performance and be successful and such a package will keep the firm competitive when looking for managerial talent.

I would believe more people would disagree with Daniel’s position that would agree. I also think some people would follow him on historical background of the company and help continue that culture. Him focusing on development of products and not maximizing one's

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competitive advantage will also help him. It will also help if he can further explain his pro- management perspective that emphasizes the potential for opportunism. Many people would prefer a higher fixed salary anyways and not have to receive a bonus.

Daniel will have to debate this package with the board member and any other board members who find it a good idea. I believe the information he can provide on the current management staff and what they have accomplished and continue to do without the bonus will help support his argument.

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