The Principal Agent Problem

Reading between the lines, the Principal Agent Problem appears to be the main issue that the SoftVest/HK/Tessler group is trying to nip in the bud.  Here are some links on the age old problem.

Wikipedia: Principal–agent problem

The principal–agent problem, in political science and economics, (also known as agency dilemma or the agency problem) occurs when one person or entity (the “agent“) is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the “principal“.[1] This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard.

Common examples of this relationship include corporate management (agent) and shareholders (principal), elected officials (agent) and citizens (principal), or brokers (agent) and markets (buyers and sellers, principals).[2] Consider a legal client (the principal) wondering whether their lawyer (the agent) is recommending protracted legal proceedings because it is truly necessary for the client’s well being, or because it will generate income for the lawyer. In fact the problem can arise in almost any context where one party is being paid by another to do something where the agent has a small or nonexistent share in the outcome, whether in formal employment or a negotiated deal such as paying for household jobs or car repairs.

HBS: Theory of the Firm

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. — Adam Smith (1776)

IBLJ: The Agency Problem of Lehman Brothers’ Board of Directors

One of the ways to reduce agency costs is to align an agent’s interest with a principal’s interest, because the agency problem arises due to divergent interests. For example, requiring directors to own company shares can motivate directors to work for the company’s best interest, rather than directors’ interest. However, because directors are monitors and advisors, not managers, tying directors’ compensation with the company’s financial success may compromise their ability to provide effective oversight.[20] For instance, a director may become unwilling to approve risky projects that will negatively affect the company’s short-term profits but create long-term value,[21] if he prefers immediate financial gains from the company.

Forbes: Solving The Principal Agent Problem: Apple Insists That Executives Must Hold Company Stock

Apple’s new policy requires executive officers to hold three times their annual base salary in stock, and executives have five years to satisfy the requirement. The document also restates the company’s existing policy of requiring the chief executive to hold 10 times his annual base salary and nonemployee directors to hold five times their annual retainers, policies that were mentioned in the January proxy.

Constitution Daily: On This Day: “No taxation without representation!”

“That it is inseparably essential to the freedom of a people, and the undoubted right of Englishmen, that no taxes be imposed on them, but with their own consent, given personally, or by their representatives. That the people of these colonies are not, and from their local circumstances cannot be, represented in the House of Commons in Great-Britain. That the only representatives of the people of these colonies, are persons chosen therein by themselves, and that no taxes ever have been, or can be constitutionally imposed on them, but by their respective legislatures,” read the passage.

3 thoughts on “The Principal Agent Problem

  1. I think you have nailed down the HK concern with TPL exactly!

    They seem concerned with a few themes of the new active management TPL, and want to have a new governance structure in place. I feel they are fine with a more active approach as long as new compensating controls are in place for oversight. And it would be so much better of the CEO and CFO and board members had significant “skin in the game”. Something is a bit odd when a small investor like me has more shares than four of these five individuals currently.

    Will analyze all the information that I expect to receive from the white and blue card proxy process, but am leaning heavily towards Oliver.

    Liked by 1 person

  2. Ted – I always look forward to your insightful, well-grounded comments. I do think it was the huge increase in compensation for Glover and Packer that was the tipping point for this activism. Not saying they don’t deserve to be well compensated for outstanding performance, but the thought that the decisions are made by such an insular group of trustees is cause for concern. The last thing we would want for the long-term viability of the trust is for decisions like this to come into question. It is astounding that a small investors such as me (and probably many other long-term holders) have more ownership than two trustees and two executives COMBINED. Eric Oliver has my votes!

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  3. Jeff—thanks. And yes, you stated it better than I did, its the similar math for me also. Which really shouldn’t happen for a 7 billion market cap company.

    Glover is 34, so some of this may be mistakes of youth to not see how the optics of the huge pay increase and bonus look coupled with minimal stock ownership. He may have felt the results of the company speak for themselves….by any yardstick its been exceptional. The salary and bonus may be very reasonable, but also with the big increase in director pay, it feels like a weak board that is doing what the executives want, and not the other way around.

    An idea if I was Glover would be to proactively make some oversight changes, plan on quarterly conference calls, more data releases and more transparency. Steer the trust directors to approve this direction. That would take the wind out of the Eric Oliver sails. Because the way it looks now, my handicapping of the director race has Oliver easily winning, I think most people are going to fundamentally understand that change is needed.

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