Broadly, then, the job of a leader is to put in place mechanisms in the organization to ensure that agents’ behavior is aligned with interests of the principals. This alignment is achieved through incentives and perquisites.
Importantly, agency costs occur throughout an organization. At the organization's head, agency costs appear when the owners appoint the board to act on their behalf. The board is monitored through measures such as the strategic planning process and other governance-related and regulatory mechanisms to ensure those appointed by the owners truly act on their behalf. This is predominant in publicly traded companies but is also the case for private companies, particularly in mature generational businesses with more complex governance structures.
Moreover, one of the responsibilities of the board of directors is to appoint and monitor the CEO. Agency costs, or the potential for agency costs, will occur if the CEO's actions, decisions, or behaviors are not aligned with those of the board of directors, who are acting as representatives of the owners.
Moving down through the organization, there are also potential agency costs when the CEO appoints their management team. This potential eventuates if those top executives are not aligned amongst themselves.
If you keep the thread going, further down the organization the senior management team is charged with overseeing different areas, be it marketing, finance, IT, logistics, sales, or others. Again, there is potential for agency costs in misalignment of the senior management team with those appointed as division leaders or department heads.
These middle managers or supervisors, in turn, will employ line staff, resulting in yet another principal–agent dyad, and the potential for more agency costs.
As such, an organization represents a chain of principals and agents, with the same individuals or entities taking on either role, depending on the dyad relationship in question. Recall, at the top of the organization, the principal was the owner, and the board was the agent; then the board was the principal, and the CEO was their agent; then the CEO was the principal, and their agent was the top management team. The top management team members then represent the principal in their dyadic relationship with their line employees. And so on.
So, as should be evident, agency costs, or the potential for agency costs, are ubiquitous throughout all organizations. It is for this reason that agency is one of the frameworks in the keystone meta-framework.
Family enterprises are not immune to agency costs, or the potential for agency costs. They too incur costs throughout the organization and the family. In the early days, the owners are also the managers, so there is a reduction of agency-related costs. But as the company evolves and the family grows, the owners typically must appoint non-family employees and managers to assist in operations and non-family directors to assist in governance. Family and non-family members will contribute to the potential for agency costs if they are not aligned with the values, beliefs, or vision of the core ownership group.
In family enterprises there are four specific categories of agency costs. The first category is probably the most common and easiest to comprehend: entrenchment. Here, a founder, or any senior executive or other employee becomes entrenched in their position and their way of doing things. This happens not only in the domain of business-owning families, but, typically, entrenchment-related agency costs will be incurred if a senior executive or, particularly, an incumbent leader is not willing to succeed responsibility to the next generation and stays too long in their role. These costs relate to being wedded to old ways and the unwillingness to embrace change and innovation, which, paradoxically, were likely the hallmarks of the executive's earlier leadership and a major reason for their success.
The second theoretical dimension related to agency costs is adverse selection. This effectively says that the best person for a given job or position should be appointed regardless of whether that individual is family or non-family. As is the case for non-family businesses as well, there is a large potential to incur agency costs should the wrong person be appointed, such as when nepotism is involved.
The third agency-cost-related category relates to information asymmetry. Here, there will be cost incurred, or the potential for costs, if information is kept from people who should be given access to it or used inappropriately by those with access. For example, information asymmetry manifests in the form of insider trading in publicly traded companies, when someone who has access to superior information acts on that information to benefit themselves at the company's expense. This type of cost is potentially rife in family enterprises where those working for the business in day-to-day operations or in executive roles have access to information that those not working in the business lack. It also manifests in boards, when a board member has access to information others do not and acts on that information in an inappropriate way.
Finally, the potential for agency costs is also associated with altruism. Here the problem can be that all family members will be treated equally—such as offered the same compensation or similar-level business roles—despite their divergent contributions to the business or the family in governance or other roles. This is a recipe for disaster.
To recap, entrenchment is when incumbents overstay their welcome, preventing effective succession; adverse selection is also known as nepotism and causes problems when family members are appointed to positions for which they are not qualified; information asymmetry, also known as insider trading in publicly traded companies, denotes situations where access to superior information is used inappropriately; and altruism, in this context, involves treating everyone equally regardless of what they contribute (Illustration 2).
Illustration 2 AGENCY
Achievement of continuity requires understanding and minimizing agency-related costs. One way to do that is through the Continuity Canvas's four essential plans. A fundamental continuity model concept, and a key way to reduce agency costs, is to ensure that agents act as stewards, as we discuss next.
Stewardship Theory
Stewardship theory defines relationships based on behavioral premises not addressed by the principal–agent interest divergence that agency theory poses. According to stewardship theory, agents’ objectives can be aligned with those of the organization, and the utility gained through pro-organizational behaviors is higher than those gained through individualistic, self-serving behaviors.
If the agent is intrinsically motivated, they will most likely design an organizational setting where higher-order needs are encouraged and fostered. In an effort to pursue these higher-order needs, agents will be motivated to work harder on behalf of the organization, a condition that aligns their behaviors with their principals’ interests. Under such conditions, the potential for opportunism is reduced (but not eliminated) as agents gain little or no utility (and, in fact, may lose utility) by pursuing tangible, self-serving economic rewards. The more agents value intrinsic rewards, the less likely they will be to deviate from the interests of the organization and the more likely that they will protect their principals’ interests.
According to stewardship theory, the stewards’ objectives are aligned with those of the organization and its stakeholders, including goals such as sales growth, innovation, and profitability as well as nonfinancial objectives, such as ensuring the passing of the firm to the next generation. Indeed, stewards not only recognize their obligation to protect the interests of the organization but also believe that they are morally obligated