I’m studying and need help with a Economics question to help me learn.
ONE: Incentive conflicts are common occurrences within organizations and take place when the employees feel that they are not encouraged or motivated to carry out their tasks. The employee acts rationale to the system at hand, and as a result, it’s upon the HRMs to implement the best incentive programs. John et al., (2015) outlines that there are endless means of creating incentives such as spousal death benefits, unlimited sick days, personal growth, offering a flexible schedule, tuition reimbursements among others. However, the major challenge arises when the employer fails to identify the actual needs of the employees and ends up addressing the inappropriate courses. To some extent, some organizations end up even not offering any benefit at all. These situations lead to incentive conflicts which can be very detrimental to a firm. It is always crucial to obtain the necessary information from the employee and secondary resources to come to more informed decisions. Pomeranz (2015) suggests that in cases where there exists centralized decision-making authority, one should strive to transfer the needed information to decision-makers. In a decentralized firm, it would be advisable to move decisions to those with information. Such an approach ensures that the most appealing incentive compensation schemes are implemented. However, it is assumed that in an ideal situation, decision-makers always possess information that is necessary to make profitable decisions.
Though I have not been directly engaged in an organization with incentive conflicts, I once read of an Auction House X that suffered such effects. The action house happened to employ experts to convince art owners to use the auction services. Firm X earned money by charging the art owners a percentage of the final price at auction, a percentage negotiated by the art experts. Within a short period after the hiring practices, the auction house realized that it was consistently recording loses each day. This aspect lowered its value such that it had challenges paying the workers. It was only after research that the management realized that the experts traded low prices for kickbacks as a way of self-motivation now that the organization could not. The organization realized that it had omitted incentive programs that are quite significant for the productivity of the employees. At times, the management had been offering minor and insignificant incentive programs that were coldly received by the sales experts. This implies that the organization could have escaped incentive conflicts and revenue loses if, at all, it had paid much attention to employee concerns. It seems that the manager-employee relationship was the primary cause of this impediment. There are chances that the experts could not approach the manager to address their concerns, and at the same time, the manager was less concerned. He acted as a boss rather than a leader. A good relationship could balance the organizational stool, and the organization could accumulate considerable profits in the long run. Indeed, incentives are critical aspects of any organization since the workers need to feel more appreciated and valued. Therefore, incentive conflicts should be prioritized and handled with the effort they deserve (Costello, 2013).
Costello. A. (2013). Mitigating Incentive Conflicts In Interfirm Relationships: Evidence from Long Term Supply Contracts. Journal of Accounting and Economics. Retrieved from:https://www.sciencedirect.com/science/article/abs/pii/S0165410113000153
John, K., Knyazeva, A., & Knyazeva, D. (2015). Employee rights and acquisitions. Journal of Financial Economics, 118(1), 49-69.
Pomeranz, J. L. (2015). Participatory workplace wellness programs: Reward, penalty, and regulatory conflict. The Milbank Quarterly, 93(2), 301-318.
TWO: Brickley, Smith, & Zimmerman (2019) highlight five owner-manager incentive conflicts, which include effort choice, perquisite taking, differential risk exposure, differential horizons, and overinvestment. Incentive conflicts are concerns that firms must protect against. The problem arises when the individual incentives of utility maximization do not align with the firm’s objective of profit maximization. This is called the principle-agent problem, and is seen in situations where an owner’s (principal) objective to maximize profit for the firm is not met by the manager’s (agent) personal interests. In other words, “What is in the best interest of the management is not necessarily the same as what is in the best interests of the shareholders” (Worstall, 2013, para. 3). Many years ago I use to be a real estate agent and an example of this can be seen in the concept of dual agency. Dual agency refers to when one real estate agent represents both the buyer and seller in a transaction. In Florida, dual agency is illegal, but the state implemented a law that allows agents to represent both buyer and seller under the term, “transaction broker”, whereby the agent is relieved of any fiduciary responsibility to either party and just acts as a mediator for the transaction. The conflict can easily be seen. If an agent represents the seller, it is their fiduciary responsibility to get the seller the highest price possible for the house, whereas if the agent represents the buyer, it is their responsibility to get the buyer the lowest price possible. In dual agency the agent would not be as likely to work as hard for the buyer as they would for the seller because their commission would be greater if they sell the house at the highest price possible. In this case the agent would be putting their personal interests ahead of the buyer’s (principal) interests.
Organizations try to control incentive problems through contracts. In 2013, Apple created new contracts with management that required them to own company stock. According to Worstall (2013), Apple required senior executive officers to “hold triple their base salary in company stock” (para 5). Ross (2019) explains why Apple did this when he reported “This move was intended to align executive interests with those of shareholders. Management no longer benefits from actions that harm shareholders as the significant investment owned by executives forces them to view their own interests as being identical to investor interests” (para. 10). This is an example of how a contract addresses the incentive conflict of differential risk exposure and differential horizons. Executives now must act in the interests of the company because what is best for the company will increase the benefits of the executives. Ross (2019) states, “Executives must pay attention to issues impacting the company’s health and long-term growth”… and “this will keep the company competitive for the future” (para. 11).
Brickley, J., Smith, C., & Zimmerman, J. (2019). Managerial Economics and Organizational Architecture. (6th ed.). McGraw-Hill/Irwin: New York.
Ross, S. (2019). How Do Modern Corporations Deal With Agency Problems?. Retrieved from https://www.investopedia.com/ask/answers/041015/how-do-modern-corporations-deal-agency-problems.asp.
Worstall, T. (2013). Solving the Principal Agent Problem: Apple Insists that Executives Hold Company Stock. Retrieved from https://www.forbes.com/sites/timworstall/2013/03/01/solving-the-principal-agent-problem-apple-insists-that-executives-must-hold-company-stock/#361.