[4] Professor Jensen also wrote an important paper with Eugene Fama of University of Chicago titled "Agency Problems and Residual Claims".
[5] These works categories agency costs into three main sources: The relationship between a company's shareholder and the board of directors is generally considered to be a classic example of a principal–agent problem.
In such case, traditional mechanisms of corporate governance such as shareholder activism and proxy contests may be less effective due to the fragmented nature of ownership.
[12] The classic case of corporate agency cost is the professional manager—specifically the CEO—with only a small stake in ownership, having interests differing from those of firm's owners.
Instead of making the company more efficient and profitable, the CEO may be tempted into: Information asymmetry contributes to moral hazard and adverse selection problems.
Similar issues arise with respect to obligations under a contract between the director and the company, given the operation of the privity doctrine.
[21] Another key method by which agency costs are reduced is through legislative requirements that companies undertake audits of their financial statements.
In jurisdictions outside the US and UK, a distinct form of agency costs arises from the existence of dominant shareholders within public corporations (Rojas, 2014).
The paper summarised that the executive compensation design should consider the potential of creative risk-taking and agency costs.
In a very simplistic sense, this meant that managements compensation was pegged to stock performance and would mean any decision they made would be to the benefit of themselves (agents) and principals (shareholders).
Whilst in theory the concept was sound, it meant that Enron's management could now deceive the markets for their own monetary gain, and they did just that.
Higher management decided to take on high debt and risky activities, leaving these transactions 'off the books' and essentially meaning Enron was falsifying information.
In the case of Arthur Andersen again reiterating the power of the principal-agent problem, where the accounting firm (principal) trusts and follows orders from the chiefs (agents), who benefit greatly from the business of a large company like Enron.
The collapse of the two giants shook Wall street, and finance around the globe, leading to Enron's CEO Jeffrey Skilling being sentenced to serve 24 years in prison, as a result of various counts of conspiracy, fraud and insider trading.
Another potential example of the agency-cost problem (which also gives rise to questions of corporate social responsibility) arose with respect to the James Hardie Scandal, where James Hardie Industires sought to avoid payment of settlements to those former employees suffering from by asbestos related illnesses.
[28] This divergence in interest, even where it address an issue of corporate social responsibility rather than strictly monetary concerns, could be considered an example of agency cost.
For example, they design fair and transparent compensation and incentive schemes, provide training and career development opportunities, and establish clear communication channels between employees and management.
The ultimate goal is to create a more engaged and motivated workforce to reduce potential labour agency costs.
The authors claim that, by providing for the interests of both employees and managers, HR systems can help reduce labour agency costs.
In conclusion, the paper stated that HR practises for reducing labour agency costs could work significantly.
For example, piece rates are preferred for labor tasks where quality is readily observable, e.g. sharpened sugar cane stalks ready for planting.
Where effort quality is difficult to observe, e.g. the uniformity of broadcast seeds or fertilizer, wage rates tend to be used.
Roumasset (1995)[35] finds that warranted intensification (e.g. due to land quality) jointly determines optimal specialization on the farm, along with the agency costs of alternative agricultural firms.