Managerial Interests and the Principal-Agent Problem

It is a common misconception that managerial economists’ main function is to maximize profits, thereby increasing the firm’s value. However, Allen, Doherty, and Weigelt (2013) reveals that this is not the case. Managerial economists are also responsible for recognizing various economic and organizational goals such as those that aim at enhancing the organizational long-term value, such as establishing the organization’s brand name internationally and building the firm’s market share. The study divulges that other managerial economists’ goals do not necessarily deal with the organizational value and instead focuses on increasing managerial compensation. Since managerial economists have varying interests, focus, and responsibilities, it may lead to a state called the principal-agent problem. By definition, the principal-agent problem denotes a state where there a conflict in priorities, particularly between a group or an individual and the authorized representative selected to act on their behalf (Allen, Doherty, & Weigelt, 2013). In retrospect, an agent’s actions may be deemed contrary to the principal’s best interest. 

“Managers are agents who work for the firm’s owners, who are shareholders or principals. The principal-agent problem centers on whether managers may pursue their own objectives at a cost to the owners. We ask students in our class, “If we send you to Atlantic City with our money, would your behaviour change?” Because the firm’s owners find it difficult to adequately distinguish actions that maximize profit and those that do not, managers have incentives to enrich themselves. To deal with this problem, owners often use contracts to converge their preferences and those of their agents. For example, owners may give managers a financial stake in future success. Many corporations use stock option plans, whereby managers can purchase shares of common stock at less than market price. These plans give managers incentives to increase firm profit and comply with owners’ interest. There is some evidence these plans do change behaviour” (Allen, Doherty, & Weigelt, 2013, p.6).

Managerial interest is an important aspect since it helps in defining the principal-agent problem. It is mainly because managerial interests and the consequent principal-agent problem may define international managerial economics’ success or failure. For instance, scholars assess that when managerial economists must decide between the maximization of an organization’s value and the increment of payoffs to one manager or management team, most may be inclined to opt for a relatively selfish path; this is a common trait among managers (Allen, Doherty, & Weigelt, 2013). However, evidence reveals that when managerial economists own more than 5% of the organization, they may prove to be unselfish thus perform better to earn profit from their investments. Although this seems like a strategic approach to avoiding the principal-agent problem, it has adverse effects such as moral hazard issues.