Agency Problem

What it is:

When can it happen?

• In business – When CEOs prioritize short-term stock prices over long-term company growth.

• In investing – When financial advisors recommend high-fee products that benefit them more than their clients.

• In healthcare – When doctors perform unnecessary procedures because they earn more from surgeries.

• In governance – When politicians make election-driven promises that harm long-term economic stability.

• In workplaces – When employees manipulate systems to secure promotions or job security rather than focusing on company goals.

How to avoid this misjudgment?

• Identify incentives – Always ask, “What does this person gain from this decision?”

• Seek transparency – Understand how decision-makers are compensated.

• Align rewards with outcomes – Ensure that personal gains are tied to long-term success, not just short-term benefits.

• Get second opinions – Cross-check important advice, especially in finance and healthcare.

• Encourage accountability – Implement monitoring systems that track both actions and incentives.

Examples of the Agency Problem in Action

Business Perspective

1. Executive Bonuses & Stock Buybacks
• CEOs with stock options often buy back shares to inflate stock prices rather than reinvesting in innovation.
• Blind Spot: They believe they are acting in the company’s best interest, but the focus is on short-term optics over long-term stability.
• Lesson: Executive compensation should be tied to multi-year performance, not just stock price fluctuations.

2. Xerox’s Sales Incentive Flaw
• Xerox found that salespeople were pushing an older, inferior product instead of a new, better one.
• Why? The commission structure rewarded selling the old product more.
• Lesson: If incentives aren’t designed correctly, employees will optimize for what benefits them most, not the company.

Investment Perspective

1. Financial Advisors & Commission-Driven Advice
• Brokers often sell high-fee mutual funds instead of low-cost index funds.
• Why? Higher fees mean bigger commissions, even if the client’s returns suffer.
• Lesson: Investors should always ask, “How does my advisor get paid?” before making financial decisions.

2. Venture Capital & Startup Growth
• Many VC-backed startups focus on growth at all costs rather than building a sustainable business.
• Why? Investors are incentivized to exit early, even if it means burning cash recklessly.
• Lesson: Look for businesses that prioritize profitability, not just rapid expansion.

Healthcare & Medical Decisions

1. Unnecessary Surgeries & Treatments
• A doctor recommends surgery when physical therapy might be a viable alternative.
• Why? Surgeries generate more revenue than non-invasive treatments.
• Lesson: Always get a second medical opinion, especially for high-cost treatments.

Government & Public Policy

1. The Perpetual Re-Election Cycle
• Politicians push short-term economic policies (like excessive tax cuts) to win votes.
• Blind Spot: Voters trust the policy without considering long-term financial stability.
• Lesson: Assess policies based on long-term impact, not just electoral promises.

2. Government Contracts & Cost-Plus Pricing
• Defense contractors were paid based on a percentage of project cost, leading to deliberate cost inflation.
• Why? There was no incentive to cut costs—higher spending meant bigger profits.
• Lesson: Contracts should align company incentives with efficiency, not just spending.

Workplace & Employee Behavior

1. Manipulating Systems for Promotions
• Employees take credit for group projects or make work seem harder than it is to appear valuable.
• Why? Promotions are often based on perceived individual contributions rather than actual impact.
• Lesson: Companies should reward team success and outcome-based performance.

Key Takeaway