Benefits and drawbacks of agency relationship

Advantages and disadvantages of using commercial agents |

benefits and drawbacks of agency relationship

Cornelian Asset Managers adopt an Agency relationship model for working with financial advisers. We explain the nature of this type of. A principal who assigns agency to an agent is creating a legal relationship with the agent. Agency agreements can have many benefits for the principal, especially and necessity of agency agreements, there can also be some drawbacks. Ad agency-client relationship models: advantages and disadvantages. By María Eugenia Tena. Senior Thesis Directed by Prof. Dr. Ángel Arrese.

benefits and drawbacks of agency relationship

For example, the owner-manager may prefer a more leisurely lifestyle and not work as vigorously to maximize shareholder wealth, because less of the wealth will now accrue to the owner-manager.

In addition, the owner-manager may decide to consume more perquisites, because some of the cost of the consumption of benefits will now be borne by the outside shareholders. In the majority of large publicly traded corporations, agency conflicts are potentially quite significant because the firm's managers generally own only a small percentage of the common stock.

Therefore, shareholder wealth maximization could be subordinated to an assortment of other managerial goals.

For instance, managers may have a fundamental objective of maximizing the size of the firm. By creating a large, rapidly growing firm, executives increase their own status, create more opportunities for lower- and middle-level managers and salaries, and enhance their job security because an unfriendly takeover is less likely. As a result, incumbent management may pursue diversification at the expense of the shareholders who can easily diversify their individual portfolios simply by buying shares in other companies.

Managers can be encouraged to act in the stockholders' best interests through incentives, constraints, and punishments. These methods, however, are effective only if shareholders can observe all of the actions taken by managers.

A moral hazard problem, whereby agents take unobserved actions in their own self-interests, originates because it is infeasible for shareholders to monitor all managerial actions. To reduce the moral hazard problem, stockholders must incur agency costs. Agency costs are defined as those costs borne by shareholders to encourage managers to maximize shareholder wealth rather than behave in their own self-interests.

The notion of agency costs is perhaps most associated with a seminal Journal of Finance paper by Michael Jensen and William Meckling, who suggested that corporate debt levels and management equity levels are both influenced by a wish to contain agency costs.

benefits and drawbacks of agency relationship

There are three major types of agency costs: In the absence of efforts by shareholders to alter managerial behavior, there will typically be some loss of shareholder wealth due to inappropriate managerial actions.

On the other hand, agency costs would be excessive if shareholders attempted to ensure that every managerial action conformed with shareholder interests. Therefore, the optimal amount of agency costs to be borne by shareholders is determined in a cost-benefit context—agency costs should be increased as long as each incremental dollar spent results in at least a dollar increase in shareholder wealth.

At one extreme, the firm's managers are compensated entirely on the basis of stock price changes. In this case, agency costs will be low because managers have great incentives to maximize shareholder wealth. It would be extremely difficult, however, to hire talented managers under these contractual terms because the firm's earnings would be affected by economic events that are not under managerial control.

At the other extreme, stockholders could monitor every managerial action, but this would be extremely costly and inefficient. The optimal solution lies between the extremes, where executive compensation is tied to performance, but some monitoring is also undertaken.


In addition to monitoring, the following mechanisms encourage managers to act in shareholders' interests: Most publicly traded firms now employ performance shares, which are shares of stock given to executives on the basis of performances as defined by financial measures such as earnings per share, return on assets, return on equity, and stock price changes.

If corporate performance is above the performance targets, the firm's managers earn more shares. If performance is below the target, however, they receive less than percent of the shares. Incentive-based compensation plans, such as performance shares, are designed to satisfy two objectives.

First, they offer executives incentives to take actions that will enhance shareholder wealth. Second, these plans help companies attract and retain managers who have the confidence to risk their financial future on their own abilities—which should lead to better performance. An increasing percentage of common stock in corporate America is owned by institutional investors such as insurance companies, pension funds, and mutual funds.

benefits and drawbacks of agency relationship

The institutional money managers have the clout, if they choose, to exert considerable influence over a firm's operations. Institutional investors can influence a firm's managers in two primary ways. First, they can meet with a firm's management and offer suggestions regarding the firm's operations.

Agency Theory - duties, benefits, expenses

Second, institutional shareholders can sponsor a proposal to be voted on at the annual stockholders' meeting, even if the proposal is opposed by management. Although such shareholder-sponsored proposals are nonbinding and involve issues outside day-to-day operations, the results of these votes clearly influence management opinion.

Agencies work in a variety of models, but typically the timing and pricing will be flexible depending on your needs. Launching a new product update? Hire a PR agency for a few months to get it the attention it deserves. Need some additional resources to build a product extension? Hire an agency to build it and maintain it. The ability to scale your efforts up and down with an agency allows you to pay for work only when you need it.

You don't know what you need yet. When you hire internally, you're committing to a particular need. While your startup is still trying to figure things out, you may not know what you need yet. They have multiple skills in one place. Agencies hire people with different skills. A good marketing agency will have people from a variety of backgrounds and experience, allowing you to leverage them selectively.

Thinking about expanding your offering to a new market but not sure what that market might think? Ask if anyone at your partner agency knows about this new market. Working with a web development firm and need extra hands on a new technology?

benefits and drawbacks of agency relationship

They can help you make better decisions. Agencies work with many clients across a variety of industries and company stages. Working with them gives you the benefit of learning from their past successes and mistakes. The agency agreement between a principal and the agent must always be in writing with clear terms and conditions. The agreement should have explicit language limiting the principal's liability if the agent does something that wasn't authorized.

This protects you personally and professionally.

What Is an Agency Agreement?

References 2 31 USC - Sec. Agency Agreements About the Author Jeremy Bradley works in the fields of educational consultancy and business administration. He holds a Master of Business Administration degree.