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Conflict Of Interest: the agency problem

A Conflict Of Interest (COI) is when an employee or company is involved in multiple interests that collide. A COI will often affect decisions and benefit a third party (Investopedia, 2020).


COI can take many forms, from employees falling in love to working for competitors and even receiving bribes. The first example is often covered by the employee handbook. Here it is often stated that relations between employees must be revealed to the management to avoid COI. Management will decide whether an action is necessary concerning this blessed situation.


The second case is more severe, and laws come into effect (Rowan, 2014). Here we are talking about legal actions and possible sentences. So Conflict Of Interest is a vast area from situations not covered by law to regular crimes.


In the corporate world, one must be aware of the agency problem. This conflict refers to the interest between a company's management and stockholders. The manager is an agent for the shareholders and is supposed to make decisions that will benefit their interests. If the manager is thinking more about personal wealth and interests - then we have an agency problem (Chen, 2020). Most managers know this - and often, due to stock options, they will do their best to comply. But by doing this, they may engage in other conflicts of interest. Other stakeholders must be last in line - often the employees, and let us not forget the customers.


I have chosen to investigate the ENRON scandal - and will look into issues concerning the agency problem. Enron was one of the largest enterprises in the United States at one point. Still, Enron had a huge debt and started losing money in 1997.


Enron's leadership had an obligation to promote the interest of the investors but failed to do so. The board of directors had their self-interest in mind and covered up the increasing debt using creative accounting. The company filed for bankruptcy in December 2001. Criminal charges were brought up against CEO Kenneth Lay and other Enron key figures (Investopedia, 2020).

Shareholders wanted ENRON management to run the company to increase shareholder value. Kenneth Lay and his directors mislead the shareholders. This is an agency problem. In this case, Lay was the agent, and the shareholders were the Principals (Bloomenthal, 2019). The agency cost inflicted by this fraud was a billion-dollar loss.


Many laws have been passed to address unethical behavior like the agency problem. Worth mentioning in relation to ENRON and U.S. laws are; The Federal Sentencing Guidelines for Organizations (FSGO) of 1991, The Sarbanes-Oxley Act of 2002, The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Often, unethical violations are not solely relegated to company "insiders", also non-insiders are taking part in illegal transactions (Hayes, 2020).


In Denmark, the laws are very much the same. I did some research. We have the same problems here. Still, I believe the U.S. laws are harder - due to severe sentences. A man like Kenneth Lay was sentenced to 45 years in the U.S. (Sunseri & Rottmann, 2006). He died before going to jail. In Denmark, I estimate that he would have been sentenced to around 8 years of incarceration in a closed prison. After 7 years of good behavior, he would be transferred to an open prison and soon released. So there is a difference.


Howto discourage COI - the agency problem?


To supplement legislation, many companies have codes of conduct or ethics. A code of conduct states mission, values, and principles, linking them with conduct in the company. It lays rules for behavior as a warning. Breaking the code of conduct can result in termination and prosecution.


Employees often undergo training to learn rules of conduct and legislation, especially informing them about the agency problem (Hayes, 2020). According to Hayes, leaders must follow this rule: "Place the integrity of the interests of clients above your interests." A very used policy is to offer all leading personal stock options to avoid agency problems. A stock option gives an employee the right, but not the obligation, to buy stocks cheap after delivering specific results. It is a very used method to maintain management loyalty.


Are laws and policies effective in promoting ethical behavior?


There is no doubt that current laws and policies concerning COI do have a significant effect on managers. Both legislation and company policy has come a long way, and I consider them quite practical. We will still see cases emerge, but that is the nature of humankind.

A company's reputation is a valuable asset


According to The Ethics & Compliance Initiative (2020), ethics risk can be reduced by taking these four steps:

  1. Create a code of conduct

  2. Build a culture of integrity by informing about the code

  3. Keep talking about the code

  4. Re-evaluate the code and efforts

It is crucial to evaluate and improve the rules as times and needs change. Only having these rules is not enough. It's not enough to "print and post."


In the corporate world, the agency problem must be faced. It is vital to create a code of conduct. Furthermore, employees must be trained in ethics and behavior, also the consequences of not doing so.


References ( LEARN MORE )


Bloomenthal, A. (2019).Agency Cost Definition. Investopedia. Retrieved from https://www.investopedia.com/terms/a/agencycosts.asp


Chen, J. (2020). Agency Problem. Investopedia. Retrieved from https://www.investopedia.com/terms/a/agencyproblem.asp


Hayes, A. (2020). Code of Ethics. Investopedia. Retrieved from https://www.investopedia.com/terms/c/code-of-ethics.asp


Investopedia. (2020). The Agency Problem: Two Infamous Examples. Retrieved from https://www.investopedia.com/ask/answers/041315/what-are-some-famous-scandals-demonstrate-agency-problem.asp


Rowan, K. (2014). Conflict of Interest Examples: Avoiding Lawsuits in the Workplace. Udemy blog. Retrieved from https://blog.udemy.com/conflict-of-interest-examples/


Sunseri, G. & Rottmann, S. (2006). Enron Verdict: Ken Lay Guilty on All Counts, Skilling on 19 Counts. ABC News. Retrieved from https://abcnews.go.com/Business/LegalCenter/story?id=2003728&page=1


The Ethics & Compliance Initiative. (2020). Reducing risk. Retrieved from https://www.ethics.org/resource/free-toolkit/reducing-risk/



Written by: Allan Loumann Lissau MBA, Kommunikationsrådgiver & Recruiter, Facebook specialist, Founder & CEO / Social Image


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