Monday, April 2, 2012

Monitoring to reduce agency costs

In the last blog we looked at the rationale for organizations to delegate. In the current blog we look at the report to monitoring that organizations adopt and the various aspects involved there in.

Monitoring the agents is important given it is extremely important to reduce the agency costs for the principals. Broadly there are 3 varieties of monitoring, which we shall discuss here.

In this direction, the principals would be extremely happy if they could access complete information of the agent’s behavior and if these are in synch with the principal’s choices it would be of the best interest. However this logic would be flawed if we consider the case of a scientist or top management who could immersed in thinking activity staring outside the window! The principal in such a scenario will not in any way be able to assess if this behavior is in the best interest or not thus, any mechanisms of using monitoring costs could only imperfectly reduce agency costs.

An alternate to monitoring the agent behavior is monitoring the outcome of the agent behavior. This approach too is not without issues - it works efficiently when the tasks are not highly programmable, but gets problematic when team production is involved. Interdependence between agents makes it harder to quantify the contribution to the output.

The third mechanism used to monitor is the use of independent directors on corporate boards. The rationale is that the independent director would be able to provide objective assessment of the decisions that board would take and contribute to reducing the agent behavior.

Through all these mechanism the attempt is to align the interests of the principal and the agent, however achieving this 100 % is extremely difficult given that delegation always creates agency costs.

No comments:

Post a Comment