Wikipedia entry: Principal-Agent Problem.
“In political science and economics, the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent, such as the problem that the two may not have the same interests, while the principal is, presumably, hiring the agent to pursue the interests of the former.”
The agency dilemma is one of, in not the, major conundrum for investors in public companies due to a fundamental set-up of the system: The people running the company don’t necessarily have the same interests as the people who own the company. Private-equity investors have two primary advantages over public-market investors: First, the leverage mechanism is superior since, unlike buying stocks on margin, the ability for a bank to call back a loan is limited. Second, a private-equity investor generally exerts operating control of the company, eliminating the agency issue. E.g., a private owner of Broadcom wouldn’t have let the CEO Henry Nicholas III blow money on coke, hookers, and helicopters. (Public-market investors have a few advantages of their own: Buying a stock on an exchange is immeasurably easier than negotiating a private transaction; there’s no control premium paid; and practically any investor can own a proportionate ownership interest in even the largest company.)
Managers want to run the biggest company. Investors want to maximize returns. A wonderfully sad example of this conflict at work is brand-new GM Chairman Ed Whitacare’s recent interview with the Wall Street Journal where he said being No.1 is “the position we should strive for… an American company that employs hundreds of thousands of people…We just want to be No.1.” There’s more. “I want to see it done quickly…the whole board wants to see it done quickly.”
Someone should remind Whitacare that GM had been No. 1 for the last 78 years. A blind focus on market share is part of the reason that GM filed its inevitable bankruptcy — the financial crisis and recession only accelerated the timing.
Maximizing market share can be a goal that leads to maximizing shareholder returns. For capital-intensive manufacturing businesses like autos, economies of scale is a powerful force. But it’s not the only force. A smaller manufacturer like BMW can be much more profitable. If Whitacare had said something like, “We’ve thought about it really hard and calculated that the best way to maximize shareholder returns is to increase market share,” that would have made sense. But instead he uses language like “an American company,” and the phrase “just want to be No. 1″ implies that is the goal, not the means to a more important goal.
Being Number One isn’t synonymous with being the best. Being the largest seller of massively underpriced hurricane insurance to Florida homeowners is like being a casino that pays out 120% on its slots. GM irrationally going after bragging rights isn’t much different.
1 response so far ↓
Douglas // August 19, 2009 at 3:24 am |
I had hoped this article would have been about health care – one of the principle areas where the p-a dilemma is a major problem. As for GM – are you really under any illusions that this is not a politicized company at this point? With Uncle Sam and the UAW now the biggest shareholders, I’m not so sure profits matter, but PR sure as hell does. It’s bad business, I agree, but GM is not a typical business anymore.