The agency problem and the role of managers in corporate governance | Managing Leadership

We have spent some time over the past weeks examining the issue of corporate governance generally, and more specifically from the perspectives of directors and owners. But, of course, managers play a role in this game, and the controversy about the wide reach of that role is what underlies much of the current corporate governance debate.

And that factor has been a strong theme in our recent reviews of the subject; in conducting them we have presented some strong critiques of the unwarranted prominence of management in the functioning of corporate governance today. So, we will spend the next few days talking about what the rightful, and most effective, place is of management in the corporate structure, and what managers ought to be doing in it.

As it happens, Wally Bock, of Three Star Leadership, offered an observation last week that serves as an excellent tool for viewing the entire discussion, and as a transition into this part of it. He pointed out that the difficulties and tensions arising out of how management has come to be viewed and to behave in the modern system of corporate organization can be understood as an agency problem.

This is indeed an excellent way to view the issue. Briefly, agency is a concept in commercial law treating the relationships between:

a principal,

an agent contracted to act within specified limits in the name of that principal, and

third parties with whom the agent interacts in the contracted capacity.

This is most typically used to discuss relationships between principals and sales representatives or certain advisors, such as attorneys, who carry on, with varying degrees of autonomy and authority, important parts of the principal’s business. However, it offers excellent perspective and terminology for our discussion, as well. In particular, the agency problem that Wally refers to is the concern that agents’ interests (this will be familiar to you) do not necessarily coincide with those of owners.

Thus, a major effort in the establishment of agency relationships is the incorporation of means to help align the interests of agents with those of the principal. This is typically attempted through creatively tailored compensation schemes, also a subject familiar to those concerned with corporate governance.

But there is one more thing that is of critical importance to the integrity of an agency relationship: an agent’s foremost fiduciary duty is loyalty to the principal. A key element of the definition of what constitutes that loyalty is that the agent must not misuse the relationship for financial or other self-aggrandizement.

Now, it is pretty clear that, certainly in the US, the loyalty issue can seem to be somewhat clouded. Indeed it can hardly be otherwise where it is typically seen as most natural and effective for the CEO to be dual-hatted as chair of the board. The moral hazard that results opens the door to creative justifications of actions that may be attacked as self-serving.

But another feature of agency law is that if the principal continues to tolerate (indeed, to support after the fact) non-contractual behavior on the part of an agent who represents that behavior as in the name of the principal, then the principal cannot later disclaim what has been tolerated. This massively important topic points to the sort of situation that can only lead to further erosion of the corporate veil, and to additional threats to the immense value of the corporate structure.

For our present purposes however, having briefly recast parts of the discussion in terms of the agency problem, let’s now assume that all of that has been rectified. We will stipulate that we have owners and professional directors in sufficient and appropriate communication, and in control of the destiny of their firms and of the managers they have contracted to manage them.

The question, now, is: what is the strategic role of these particular agents - managers - in such an environment? We will turn to that, next, and hope you will join in.

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Today’s tips: Speaking of agency relationships - agents sometimes can get fired, or become unable to fulfil their duties, unexpectedly. Please see this brief but excellent treatment of this topic by Beverly Behan in her most recent Business Week column.

There is a lot, certainly, of importance to be discussed in the management field, and the change process and its management are definitely among them. As I’ve noted repeatedly, here, Steve Roesler, of All Things Workplace, provides a particularly illuminating, insightful, and practical discussion of this in his current series. It approaches the subject from a practical point of view, addressing issues that normal people grapple with and find, well: normal.

But any fertile field will throw up its riot of weeds, and change, unfortunately, is choked with them. In that light, and whatever your views on this topic may be, please take a moment to read this penetrating criticism of the change management industry, by John Fletcher, guest-posting at Carmine Coyote’s Slow Leadership; it is well worth your time.

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