In today’s business landscape, the Principal-Agent conflict is a prevalent issue observed at various levels and within many companies. As organizations grow larger, this conflict tends to arise more frequently.
Description of the Principal-Agent Conflict: The Principal-Agent conflict arises when the interests of management and shareholders are misaligned or opposing. While shareholders focus on maximizing profits, increasing return on investment, and enhancing the company’s value and stock performance, management seeks prestige, greater compensation, and expanding their network. These divergent interests give rise to the Principal-Agent conflict as their objectives are not aligned.
Impact of the Principal-Agent Conflict: The Principal-Agent conflict has implications at multiple levels, but its impact is particularly detrimental when it affects the organization’s strategic decision-making.
Types of Principal-Agent Conflicts:
- Strategic Conflicts: Often, managers make strategic decisions based on the adoption of specific technology platforms merely because acquiring skills in those areas carries higher market value for their professional growth. However, these decisions may not necessarily align with the organization’s strategic goals. For instance, an accounting manager may choose to use SAP instead of QuickBooks, despite the latter being a more flexible accounting system better suited for the agile adaptation required by a growing company. However, the accounting manager’s decision could be influenced by the fact that possessing SAP skills could lead to a 20% higher salary in the job market. The same applies to databases like Oracle or other robust systems, which may not be suitable for medium-sized or startup companies, but offer more benefits in terms of the manager’s professional growth rather than overall profitability and organizational value.
- Human Resources Conflicts: It is common for managers to prefer overseeing a department with a larger workforce rather than a smaller one. This perception is highly valued in the job market, leading managers overseeing larger departments to prioritize a robust headcount over an efficient and compact team.
- Managerial Myopia: Many managers base their decisions on avoiding risks that might expose their own shortcomings. New businesses and emerging technologies often present lucrative and strategic opportunities, but also carry higher risks of failure if not managed by experts. Managers tend to shy away from taking risky decisions to avoid exposing their mistakes and potential dismissal. However, investors benefit from assuming risks with the guidance of experts, as this enhances profitability and market positioning.
Solutions to Overcome the Principal-Agent Conflict:
- Making Executives and/or CEO Shareholders: By aligning the interests of executives and/or the CEO with shareholders, the Principal-Agent conflict can be mitigated. When executives and/or the CEO also hold shares in the company, their objectives become aligned, promoting long-term, short-term, and strategic benefits.
- Communication and Information Sharing: Maintaining clear communication channels and sharing relevant information between shareholders and management is crucial to overcome information asymmetry and align objectives. Establishing transparent communication about shareholder objectives and management goals allows everyone to work toward the same direction.
Conclusion: The Principal-Agent conflict is a common challenge in businesses, but it can be overcome by implementing measures that align management and shareholder interests. By making executives shareholders and fostering effective communication, organizations can optimize their operations, mitigating the negative effects of this conflict.