Agency Cost Management in the Digital Economy

Agency Cost Management in the Digital Economy

Dmitriy A. Zhdanov (Central Economics and Mathematics Institute, Russian Academy of Sciences, Russia)
DOI: 10.4018/978-1-7998-2011-6.ch007

Abstract

The purpose of the present study was to find the answer to the following questions: How the growing digitalization will affect agency relations, an important element of corporate governance, and what preventive measures should be taken in this situation? Therefore, the impact of digitalization on opportunistic behavior and agency costs was reviewed. The analysis revealed that digitalization provokes reduction of information asymmetry, leads to a decrease in the initiative of top managers, thereby changing the preconditions of opportunistic behavior. On the basis of the ordinal approach, an original toolkit was developed, which made it possible to model the identified dependencies, transformation of the agents' utility in case the principals' demands altering, and to demonstrate ways to reduce agency costs by proper selection of candidates for top manager positions. In conclusion, by means of the developed toolkit, the methodological recommendations were suggested for selecting the agents during the process of recruitment, taking into account the impact of digitalization.
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Introduction

Digital technologies are more and more actively and universally invading the economy and the corporate governance in particular. They expand the capabilities of the existing management tools, update them, new approaches and mechanisms are created on their basis. At the same time, the digitalization of business sets additional managerial tasks, the solution of which will require an adequate methodological tools and algorithmic support. The level and status of corporate management in many respects determine the efficiency of corporations and the perspective for their development. The successful operation of such entities, as a rule these are the largest enterprises, determines the condition of the country's economy in general.

One of the essential elements of corporate governance is agency relations. By this concept, we understand the relations that arise between the owners of companies (principals) and the top managers (agents) they hire, who are delegated the rights of managing the assets owned by shareholders.

The relationship between the owners of companies and agents hired by them is traditionally characterized by a whole bunch of contradictions. In literature, such contradictions are traditionally called ‘agency problems’. Problems and conflicts of agency relations derive from objectively existing circumstances. First of all, that involves the information asymmetry of the principal and the agent, and the problem of incomplete contracts, as it’s impossible to take into account all the essential job requirements in the contract concluded with the agent. These features of relationships create preconditions for the hired manager to take unilateral egoistic actions, including actions related to behavior called managerial opportunism, i.e. manifestation of the “behavioral” uncertainty of the agent (Williamson, 1985). The owners’ costs for compensation, rectification and insurance against emerging agency problems, compensation for the consequences of such conflicts are called agency costs.

Due to the speedy digitization of the economy, there arises a necessity of studying the way these processes influence corporate governance. Thus, the purpose of this study is to analyze the changes emerging in corporate governance, primarily in the sphere of agency relations; to review the specific features of managing the agency costs in the digital age; and, if such features are found, to assess possible ways to transform corporate governance practices. The object of this paper is agency relations, and the subject is - the peculiarities of implementing such relations in the digital age.

At the beginning of the study, let us briefly outline the features inherent in the digitalization of production and the economy in general. Discussing in this regard the digitalization, it should be noted that this topic is closely intertwined with the concepts of the Fourth Industrial Revolution (or Industry 4.0) and Industrial Internet of Things (Industrial Internet of Things - IIoT). This technology provides transfer to digital platforms, obtaining and transmission of information in any form and volume from anywhere in the company. It consolidates all equipment and workplaces of the enterprise into an information network; integrates powerful intellectual systems of interpreting the received information, making and implementing decisions into a unified software environment; synchronizes work of all departments; adapts chains of business processes to reach a single goal; visualizes information, etc.

Digitalization ensures obtaining information promptly, in real time mode. It reduces time and increases the quality of decision-making, accelerates implementation of the decisions, speeds up changes. The growing information awareness opens up new opportunities as well as creates business risks.

From the point of view of corporate governance, this technology helps to reduce the problem of information asymmetry, thereby helping to alleviate the agency problems and reduce agency costs. Nowadays, a large amount of internal or external data, which was previously difficult to retrieve and / or not stored in the digitized form, becomes available to interested parties, in particular the shareholders of the company. Owing to new methods and tools of data processing, e.g., Big Data technology, such information can now be promptly processed in order for the principal to monitor the activity of the agent, assess the quality of his performances, coordinate actions and decisions.

Key Terms in this Chapter

Agency Relations: Relations that arise between the owners of the companies (principals) and the top managers (agents) they hire, and who are delegated the rights to manage the assets owned by shareholders.

Agent’s Loyalty: The relationship of trust between the manager and the dominant owner, based on experience working together, being the same team players, clan affinity.

Incomplete Contract: Contract, executed between the principal and the agent, which cannot specify all the essential job requirements to assigned work.

Gaming: Practice of opportunistic behavior when the agent uses the established regularities and procedures for seeking self-interest, though initially such norms were not meant for this.

Agent’s Utility: Personal qualities of the agent, that allow to ensure high management efficiency, reduce potential agency problems and increase the value of the business.

Agency Costs: The owners’ costs for compensation, rectification, and insurance against emerging agency problems, compensation for the consequences of such conflicts are called agency costs.

Opportunistic Behavior: The behavior when the agent can provide the principal with incomplete or distorted information, can pursue self-interests notwithstanding formal and conventional norms, and make profit regardless the owner’s interests.

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