Incentive (Agency) Biases

When you consider about bad choices, mental selection or choices are not just the ones that require to be considered. If a person is considering to work or act on behalf of any other person, then there are chances of arising of bias of a different level. This issue is represented as issue problem. In this case, a project owner has to be dependent on someone else to attain the required business information. One of the good instances on this respect is of corporate management from where shareholders get division managers or even a project.

We have been highlighting various problems related to agencies. Here few of those problems that you will find in this section.

1. Concerns related to employment

Neither employees nor managers wish to lose their jobs. They try to keep up and showcase the potentiality of a company, dampening the drawbacks.

2. Capital competition

There are instances where for even scarce resources you will see managers competing. Precise but less optimistic cash flow details of a project is also a factor that managers look for. This leads to acquiring profitable and potential projects.

3. Power

An empire or a battalion, whatever you call it; managers do like creating such stuff. This gives them a sense of power over the employees, who work under him or her. If they can increase the profit or efficiency of the company, there are higher chances for that manager to get a promotion or monetary advancement.

4. Perks

Perks are something that managers do not give up at any cost. Their requests may be for a private airplane or a personal secretary. They show this as a useful addition that will only help in acquiring profit for the company.

5. Disinclination for risk taking

In most cases, managers are not so confident to take up any form of risk. This is because of the fear that if their risk taking opportunity turns into a failure, they will be the one answering the company for any discrepancies. Also, this will be a negative point.

6. Hidden slack

It is one of the abilities that a company wants from the managers. They should be able enough to cover up or tone down the issues that are presumed to rise up in future.

7. Direct theft

Now, this is an issue that can often be seen in companies. In this case, you can see employees or even managers to steal from their respected companies.The area in question is generally the cash register. But in many cases, such theft may be of information.

After going through all of these, we can get an idea where company issues are major or minor. Here are few more instances.

1. Engagement of owner and scale

If you consider small firms, chances of quarrel are higher among employees and owners. But if you compare that in relation to huge corporations, such trivial issues are seen negligible in these areas.This is because there are multiple levels from where the total operation takes place in the entire company.

1. Duration of a project

Now projects for every company are different. So for this, the duration will also vary. It is wise to step to consider in rewarding the manager and employees if they complete the project on time. Same goes for punishment if both the group is not able to put the project to a successful end.

• Opaqueness

It becomes tough to hand over the project to anyone if they are unable to understand what it actually is about. Managers cannot hand over something which they cannot take responsibility of.

1. External noise

Managerial performance is of no use for judgmental purpose in case n case luck favors the company. However, a company cannot always rely on good luck for all 9its operational functions. If they do so, there are higher chances of that company to face problems.

Mechanism

There are various methodologies with the help of which the problems of a company can be sorted. Some of the prime ones are:

• Incentives for speaking out truth

Conflicts in agencies can be toned down a lot if proper rewards are endowed on managers. In case your manager has been able to maintain all the company guidelines and helped a lot with the employees to bring down the negative effects of the company, an incentive a must for him.

There are also certain firms who undertake post- audits, which are created to assessing financial number and quality that is forecasted on the upfront of the manager. These post-audits help managers in strengthening their opportunities in relaying the accurate prediction.

• Audits

A number of decisions can be made by managers by acquiring information. It can be in case of that company to be running on independent audits and assessments. This can be done even if there is no positive participation from the end of employees.

• Reputation

Chances of undertaking bad projects become extremely less if the company in question becomes successful in creating an image showcasing management capabilities and favoring truthfulness. This helps in creating a positive track record, attracting profitable opportunities. Many companies also take the help of beautifying their corporate office so that it can create a platform for itself for consideration.

• Contingent compensation

Conflicts for agencies are hold lesser importance if at the right time, and for the right work a manager is punished or rewarded. It can be stated in the form of a textual instance of carrot and a stick. Bonus or incentives are considered as carrots, which is a token of appreciation. And from the stick,you can finalize out what can be rewarded as punishment. This is a strategy that most companies use in rare occasions.

• Manager selection

Companies prefer people for their management group, to be honest. But in addition to it, they also prefer those who are smart in working, maintain the integrity as well as saving the company from abuse.

• Capital rationing

If the manager of your company does not have a restrictive hand in utilizing company funds, it is better not to give the responsibility of financial transaction. They should be given money only for the project and as per requirement. The absence of excess will actually help them to use only what is required.

Solve it

 ANECDOTE

Fiduciary Responsibility or the Fox Guarding the Hen house

As per the report presented by Wall Street on 29^th December 2444:

In the last January, Bank one Corp was acquired by JP Morgan Chase & Co. and declared its merger. For payment of fair price by investors, JP Morgan stated all of them to filing proxy. This decision was made by taking the advice of world’s top 5 financial advisors.

For themselves, the boss of JP Morgan made the deal, negotiating ‘$56.9 billion’ as a fair price.

Again on Passing Muster’s side bar,

This opinion is considered a fair deal for shareholders.

1. Cost

Few (hundred thousand dollars – millions)

1. Purpose

Legal protections from deals regarding investor claims where the promised work is not completed with care.

• Potential conflicts

Fees of a banker is tied to price (deal)

With supplied financial data, bankers wish the deals to operate smoothly.

If bankers state the deals to be fair, they get incentives. These are in the form of money or advisory fees that they can get only after the deals get closed.

They usually for such deals as it helps in securing their professional future.

Corporate board, management, and In-house bankers; shareholders do employ them. These people are the ones who are responsible for fiduciary. No in-house bankers due to agency conflict will fire them. Not even for any personal favour.

Another of the conflicting issues that they said to be fair is acceptance of low price.

 

Links of Previous Main Topic:-

• Capital budgeting applications and pitfalls
• Promised expected typical or most likely
• Badly blended costs of capital
• The economics of project interactions
• Evaluating projects incrementally
• Real options

Links of Next Financial Accounting Topics:-

• An npv checklist
• Decision trees one set of parameters
• Projects with different parameters
• Appendix valuing some more real options