The agency view of the corporation posits that the decision rights (control) of the corporation are entrusted to the manager to act in shareholders' (and other parties') interests. Partly as a result of this separation, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders and other stakeholders.
The principal–agent problem or agency dilemma, developed in economic theory, concerns the difficulties in motivating one party (the "agent"), to act on behalf of another (the "principal"). The two parties have different interests and asymmetric information (the agent having more information), such that the principal cannot directly ensure that the agents are always acting in its (the principals') best interests, particularly when activities that are useful to the principal are costly to the agent, and where elements of what the agent does are costly for the principal to observe. Moral hazard and conflict of interest (COI) may thus arise .
Conflict of Interest
Principal-agent problems - which arise when managers act on the behalf of a firm and its investors - include potential conflicts of interest.
The deviation from the principal's interest by the agent is called "agency costs. " Agency costs mainly arise due to contracting costs and the divergence of control, separation of ownership and control, and the different objectives (rather than shareholder maximization) of the managers. When a firm has debt, conflicts of interest can also arise between stockholders and bondholders, leading to agency costs on the firm. Examples of agency costs include that borne by shareholders (the principal), when corporate management (the agent) buys other companies to expand its power instead of maximizing the value of the corporation's worth; or by the constituents of a politician's district (the principal) when the politician (the agent) passes legislation helpful to large contributors to their campaign rather than helpful to voters.
Much of the contemporary interest in corporate governance is concerned with mitigation of the conflicts of interests between stakeholders. A conflict of interest occurs when an individual or organization is involved in multiple interests that may lead to conflicts in their ability to act in the best interest of one party. In addition to conflicts of interest between managers, shareholders, and bondholders, conflicts of interest can also occur among other stakeholders of a company, such as the board of directors, employees, government, suppliers, and customers. COI is sometimes termed "competition of interest" rather than "conflict", emphasizing a connotation of natural competition between valid interests rather than violent conflict. At other times, conflicts of interest are confused with cases that might better be termed "corruption", such as bribe-taking or fraud.