Talk:Principal–agent problem/Archives/2015

&sect; removed in its entirety
Stuff below is stupid, redundant, restating the obvious thesis in a tone inappropriate for current wiki standards, etc. Lycurgus (talk) 16:09, 14 June 2010 (UTC)

The double-sided principal–agent problem (a model of corruption)
One limitation with the application of principal–agent theory is that the agent can also try to incentivize the principal. This is sometimes referred to as the double-sided principal–agent problem or sometimes more commonly as corruption.

One example, may be in the area of takeovers and top executive compensation:

It is fairly easy for a top executive to reduce the price of his/her company's stock—due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (eg. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce share price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their company's earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.

reduced share price makes a company an easier takeover target. When the company gets bought out (or taken private)—at a dramatically lower price—the takeover artist gains a windfall from the former top executive's actions to surreptitiously reduce share price. This can represent 10s of billions of dollars (questionably) transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the firesale that can sometimes be in the 100s of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives).

Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Top executives often reap tremendous monetary benefits when a government owned or non-profit entity is sold to private hands. Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis—this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell. Ironically, it can also contribute to a public perception that private entities are more efficiently run reinforcing the political will to sell off public assets. Again, due to asymmetric information, policy makers and the general public see a government owned firm that was a financial 'disaster'—miraculously turned around by the private sector (and typically resold) within a few years.