Question

Explain principal-agent problem. Select a company with operations in Hong Kong, identify and explain TWO possible principal-agent problems at two different organizational levels that it could encounter with examples. Explain how the company could be adversely affected by the two identified principal-agent problems. Suggest and explain TWO possible solutions for each of the identified problems. (20 marks) (The expected length of each question is around 350-450 words.)

Answer 1

Introduction:-

An organization has many dynamics to it and is governed by numerous people who come together to give their inputs while at the same time making suitable profits for themselves.

A principal agent problem comes into the picture when the decision of one party (agent) largely impacts the functioning, decision making or both of another. Here both parties cannot generally ensure that both of them are in sync with one another's goals and regularly doubt each other’s work because of which conflict of interest may take place.

Over the years, companies have tried their best to reduce the impact of principal agent problem by involving everyone to be a part of the decision making process and subsequently techniques have been evolved by companies over a period of time which have helped mitigate this issue.

With reference to the above statements, and the case study listed a deeper understanding of principal agent problem along with examples is as follows:-

Case Specifics:-

For the purpose of this case study, we are analyzing one of the biggest banking companies across the globe, which is headquartered in Hong-Kong. This company is HSBC bank.HSBC stands for the Hong Kong and Shanghai Banking Corporation and was founded in the year 1866. Though it is operated locally as well the parent company itself is in Hong Kong only.

We analyze the Principal Agent Problem in the company from two aspects. The top management and operationally from the legal perspective

Example 1) Top Management Level

Like most companies, HSBC has shareholders which own the business which the company runs. These owners have appointed numerous persons such as Directors, Chief Executive Officers, etc. The principal agent problems which such companies usually face are that the interest of the board of directors remain to increase budget for Human Resources whereas shareholders would want reinvestment of funds. Here a principal agent issue exists as one party wants to spend the money whereas the other to retain the same. Even though both could be correct in their own analysis, the principal or shareholders would feel that the agents (Directors and other senior officials) act on their own.

To solve this issue, it is important for companies to set benchmarks in consultation prior to taking such decisions. It should be clearly demarcated, that what percentage of the profits are to be retained and which part can be used for yearly increments. Budgeting and mutual negotiations here will play a big role.

Example 2) Operational Level

Consider, that the bank were to hire a legal team for some case pending in Hong Kong. The legal team would want in this case to earn maximum and extended the time period in which the case runs in court. This would help in raising the costs and thus earning maximum revenue for the legal firm.

To solve this issue, most modern banks deploy firms on contractual basis in which payments are pre-decided and the terms are negotiated on real time basis. Further Banks have the option of hiring lawyers themselves which can also help in minimizing such redundancy.

Please feel free to ask your doubts in the comments section if any.