Managing Professionals: How to Increase Efficiency in the Workplace
The goal of every organization is cost-efficiency. This is a compounding of two concepts which is the aim of reducing costs while experiencing a very high level of excellence or efficiency in the operations of the said group.
Even though CEOs, shareholders, and head of various organisations seek the highest possible state of efficiency and profit it is common to see people who are working under them shirk from their job responsibilities. This is not simply plain laziness or lack of motivation but is in fact a deliberate act whose end result is protecting the subordinate’s interest in the firm.
This phenomenon will be examined in detail using principles and concepts gleaned from Agency Theory, otherwise known as Principal-Agent Problem. Moreover, a case study will be performed – the analysis of the Computer and System Group Department of Thales UK to contextualise concepts and principles learned from a detailed analysis of the aforementioned theory. This paper will attempt to shed light on the following:
1. What is principal-agent problem or agency theory?
2. What are the examples of principal-agent problem as seen in a real world setting?
3. How does the Computer and System Group Department (“CSG”) of Thales UK manifest the principal-agent problem?
4. What could be the possible solutions to the problems associated with agency theory?
5. What could be the possible solutions to the efficiency issue of Thales UK in terms of the principal-agent problem?
What is the Principal-Agent Problem or Agency Theory?
The main idea that will be discussed extensively in this paper is the agency theory, also known as the principal-agent problem. Thus, in the following pages the terms agency theory and principal-agent problem will be used interchangeably and this means that both terms are one and the same.
According to Wessels, a basic definition of the abovementioned theory is as follows, “In the principal-agent problem, the principal’s and the agent’s interests differ, and as each cannot easily monitor what the other is doing, the result can be that less than optimal work is done” (2006, p. 392).
How is this possible that the principal which is oftentimes the financier, owner or the one who has made a significant investment in a venture can spend a lot of money and yet unable to manage effectively the enterprise? Part of the answer can be found in Stewart Clegg’s extensive study about organizational theory where he said that larger and more complex business enterprises a single individual may be unable to do all the crucial aspects of the operation in a timely and effective way, “This inability does not reflect necessarily, a lack of will to accomplish all these tasks. Rather, individual bounded rationality and real constraints ion time and energy may make it impossible to conduct business without significant delegation of authority” (1999, p. 120).
The theory gets clarified by Grossman and Hart who illustrated the concept through the following statements “Consider two individuals who operate in an uncertain environment and for whom risk sharing is desirable. Suppose that one of the individuals (known as the agent) is to take an action which the other individual (known as the principal) cannot observe […] the action which is optimal for the agent will depend on the extent of risk sharing between the principal and the agent” (1992, p. 302).
Another similar definition with a slight variation is given by Robert Wright who remarked that the principal-agent problem is a case of moral hazard where the owner (principal) is unable to monitor the actions of his agent (employee or other person charged with the principal’s property) and he added, “If the agent’s interests differ from those of the principal […] the agent will take advantage of the principal through outright theft, fraud, slacking, or other means” (2002, p. 37).
According to Fisse and Braithwaite the most widely cited version is that of Jensen and Meckling that is quoted as follows, “The private corporation or firm is simply one form of legal fiction which serves as a nexus for contracting relationships which is also characterized by the existence of divisible residual claims on the assets and cash flows of the organization which can generally be sold without permission of other contracting individuals” (1993, p. 75).
From another perspective, Stewart Clegg sets forth the insights of Jensen and Meckling with regards to agency theory and he quote:
The problem of inducing an ‘agent’ to behave as if he were maximizing the principal’s welfare is quite general. It exists in all organizations and in all cooperative efforts – at every level of management in firms […] The development of theories to explain the form which agency costs take in each of these situations (where the contractual relations differ significantly), an dhow and why they are born will lead to a rich theory of organizations…(1999, p. 119).
Jensen and Meckling as quoted by Fisse and Braithwaite wanted to show that when two or more individuals come together to establish an enterprise one of them will have to be the financier and the other one is the agent having no stake in the venture but has the power to make decisions that could make or break the undertaking. It is at this point where contracts are made it could be written or not, spoken and unspoken at the same time. The “contracts” are agreement made by the principal and the agent that both are responsible for making the most out of the resources at hand.
The idea of agreement or “contracts” was highlighted by Robert McAuliffe when he remarked that, “…the incentives of managers often differ from those of the shareholders and the efforts of the managers are impossible or too expensive to monitor. This would not be a problem if an enforceable contract could be drawn up that specified every duty of the manager and matched performance incentives to outcomes perfectly” (1999, p. 156). But the author himself had already conceded that doing so is not only impossible but impractical for the costs involve would be prohibitively high.
In the typical scenario described above, the agent has nothing to lose and everything to gain. Now expanding the understanding with regards to the principal-agent relationship to include “…relationships between employers and employees, clients and lawyers, and buyers and suppliers…” then the implications are staggering (de Rond, 2003). This means that the phenomenon of principal-agent problem is widespread and the tendency of the agents to shirk or abuse their authority is a very serious aspect of an organisation’s operation that requires the careful attention of the principal – the shareholder, financier, or owner.
In 1998 Michael Jensen simplified his original proposition concerning the theory and he wrote, “Agency theory postulates that because people are, in the end, self-interested they will have conflicts of interest over at least some issues anytime they attempt to engage in cooperative endeavours” (p. 48).
The issue concerning agency theory can be traced back to the sudden shift of social and economic structure that was brought about by the Industrial Revolution. In the past people are under religious and social laws that try to regulate the social and spiritual aspect of life. When it comes to working it is generally understood that ones degree of work is proportional to the needs of their families. If a fisherman will go to the sea and catch some fish, the amount of work that will be expended is only enough to provide for the fisherman’s immediate needs. The surplus will either be traded or bartered but the first level of recipient are those that are in close proximity to the fisherman.
According to Wajcman and Edwards the industrial revolution radically changed how modern man sees work and the needed motivation to continue working and they wrote:
With industrialization, a major historical shift in the organization of work took place […]
With the rise of industrial capitalism, this gave way to an arrangement whereby household members worked for employers in exchange for wages. Rather than producing goods to satisfy their own needs, most people became employees at places separated from their home (2005, p. 19).
This simply means that there are now many factors that will hinder man from doing his utmost best in the workplace or in doing labour. It used to be that the person man or woman requires very little prodding to initiate work, continue doing so for the whole day, and maintain a high level of commitment and work excellence. How is this so? Well, if the individual does not work then he will not eat. If the man of the house refuses to do meaningful work then his family will not only go hungry but they will suffer the consequence of poverty.
In the modern context a person can dodge his responsibilities and still able to collect his pay check and still able to provide for his family. This is where the agency theory comes into play as an effective tool in allowing top executives and shareholders on the danger of not having appropriate monitoring schemes and other methods of ensuring efficiency in the work place. To further increase understanding on how agency theory is manifested in the workplace the following case study will be used.
At the heart of the agency theory is a belief that man’s action is closely related to the perceived incentives available for the taking. Michael Jansen asserts that it is wrong to believe that action is possible in the absence of incentives and he remarked:
It is inconceivable that purposeful action on the part of human beings can be viewed as anything other than responses to incentives. Indeed, the issue of incentives goes to the heart of what it means to maximise or optimise in fact to the very core of what it means to choose. Rational individuals always choose the option that makes them better off as they see it (1998, p. 40).
Aside from the above-mentioned difficulties there is another aspect of the principal-agent problem that poses a serious threat to the firm. This was pointed out by Martin Ricketts when he said, “In an uncertain and complex environment it will usually be difficult for an outsider financier to evaluate managerial competence and to distinguish good decisions […] Because managers are much better informed about the affairs of the company than are the financiers, the hidden information or adverse selection problems is serious” (2002, p. 269). In the following pages the proponent will look at how the assumptions concerning agency theory is made evident in the world beyond the hypothetical and into the practical.
As Seen in the Real World
How do the conjectures regarding the principal-agent problem manifests itself in the real world setting? Due to the complexity of the modern workplace it is increasingly difficult to maintain proper checks and balances in the firm. In this regard Wajcman and Edwards argue that, “… in the absence of such control by or on behalf of the principal, the agents will pursue their own agenda, which may embrace raising their own salaries or becoming lazy and inefficient” (2005, p. 204).
In order to get a better handle of the theory a real company will be examined using the concepts, ideas, and principles gleaned from the discussion made a while back. A firm from the UK will be the subject of the case study. This organisation was chosen for this enquiry because the proponent is a former employee of the said firm and therefore familiar with their operation.
The firm that will be placed under the microscope is a solutions provider from the United Kingdom, a company called Thales UK. In the industrial revolution it was the turn-of-the-century type of factories that provided a clear image of what the industrial revolution is all about. Now, in the modern day “information age” it is companies such as Thales UK that best describe the spirit of the information technology revolution.
Thales UK is a solutions provider, systems provider, and IT firm rolled into one. It is one of the best companies in the United Kingdom that offers solutions to Britain’s aerospace, defence, security and service system needs as enumerated below (see Thalesgroup.com/uk):
· Homeland Security (Air Defence)
· Identification (Air Traffic Management)
· Uninhabited Aerial Vehicles (Military Radio Communications)
· Vehicle Systems (Simulation)
· Weapon Systems (Soldier Systems)
· In-Flight Entertainment (Avionics)
· Information Security (C41 Systems)
· Intelligence, Surveillance, and Reconnaisance (Combat Management Systems)
· IT Services and Outsourcing (eGovernment)
· Maritime Security (Electron Devices)
· Navigation (Electronic Warfare)
· Optronics (Engineering and Consulting)
Looking at the company’s website and even a close inspection of their facilities will only provide positive reinforcement to the image that they are projecting to the public. The firm will not reveal its weaknesses after all the company is trusted with the lives of those serving in the UK’s military forces. But just like many firms, the problems associated with the agency theory can be seen in Thales UK because it is a large organization having 9,000 employees at 60 locations throughout the region.
The principles of agency theory and principal-agent problem are manifested in the daily operations inside Thales. The proponent of this study, being a former employee of Thales can specifically pinpoint where principal-agent problems did occur at a significant level at Thales UK. It is in the Computer and System Group Department. Before going there it must be made clear that these types of problems as shown earlier are not obvious. Strengthening the claim of the above-mentioned theorists that the principals of the firm are unaware of the potential damage their agents are causing the organization.
The said department is a very important part of the organisation judging from the fact that at the core of the company one can see software development taking a major slice of the activities and work load. Thales UK is also dedicated to update and upgrade software that was sold to previous clients. Aside from that the company is always on the lookout for cutting edge software applications. Therefore Thales UK’s premium human resources are the programmers and software engineers.
The software engineers who not only are expert in writing software but also in the design of an application suited for the needs of the clients. In order for the software engineers to succeed they not only need to create excellent applications that will satisfy the needs of their clients but they also have to rely on a group of underlings that would have to do the menial tasks of programming basic parts of the software. This is where junior engineers come into play. They waited on the senior engineers to tell them what to do.
In today’s object-oriented programming style a group of people can write pieces of the software separately and then come together near the end of the deadline period and then the various components can then be “stitched” together to form one flawless application. So the senior engineers can stay on top of the project, able to see the overall picture and then subdividing the work load passing up the pieces down the line to junior engineers.
The easier parts or the routine aspect of writing software is delegated to the assistants while the more senior engineers focus either on the overall design or the more difficult aspects of the programming requirements. The problem now becomes obvious. The junior engineers can be fed with crumbs all the way while the senior engineers withhold the more juicier part of the project – those that could increase their experience, skill sets, and knowledge about the firm, the clients and software engineering in general.
Why the senior engineers would keep the junior subordinates in the dark is easy to answer. One only has to recall a basic understanding of human behaviour and of course agency theory. The senior engineers see the upcoming junior engineers as a threat. The subordinates threaten the established status and position of the senior engineers. Management now can threaten firing them if they shirk from their duties or break company rules. But if management will not be able to find replacement the senior engineers become untouchables and therefore irreplaceable. This is a good way of securing tenure and increasing their value in the organization.
This behaviour is another variation in the principal-agent problem. Still, there are major differences as compared to the conventional models of principal versus agents that was discussed in the preceding pages. It therefore requires creativity in dealing with this newer form of relationship between a principal and agent which in this case is translated as a relationship between the manager and the senior software engineers under his supervision. Before going any further, the proponent will show how the principal-agent problem is being solved in the traditional shareholder-manager and employer-employee type of working relationship. From there the proponent will find similar characteristics and possible common ground between the procedures used to eliminate the problems in their respective industries and compare it to the case study of CSG department of Thales UK.
Aside from strengthening the checks and balances with regards to the general scheme of monitoring in the company one way of increasing efficiency is by making the agents realise the futility of merely looking for their self-interest and personal gain. Jensen explains it in this manner:
… because conflicts of interest cause problems and therefore losses to the parties involved, the parties themselves have strong motivation to minimise the “agency costs” […] This conservation of value principle is the basic force that motivates both principal and agents, or partners to minimise the sum of the costs of writing and enforcing (implicit and explicit) contracts through monitoring and bonding, and the residual loss incurred because it will not pay to enforce all contracts perfectly (1998,p. 47).
There are many ways to enforce the “unwritten” contract that managers ought to perform their best or be penalized by the owner or financier. One is the actual drawing up of enforceable contracts where the principal specifically enumerates his expectations and if the manger does not deliver then the manager can be fired and replaced with a more competent person.
Another way to enforce high standards is to make the manager realise that his marketability as well as his reputation is at stake if his performance will pull down the company. In this regard McAuliffe asserted that markets can be used as a monitoring tool as well as an effective motivator and he said, “In particular, the market for corporate control and the labour market for managers penalize the managers who manage companies poorly. Thus poor managers face a greater probability of unemployment and company takeovers, lower salaries, or a reputation for having brought a firm into bankruptcy” (1999, p. 157).
In the typical employer-employee relationship, Wessels provided a type of enforceable contract that could be used to encourage above par performance from the workers and he wrote:
The most common contract is to pay workers by the hour. One way to motivate workers with hourly pay is to pay them more than they can get elsewhere. In turn, if workers are caught shirking (not putting forth their best effort), they are fired, Knowing they may be fired and that they will lose a valuable job, workers have an incentive to police themselves and not shirk (2006, p. 393).
Mark de Rond is well aware of the common view of human beings as opportunistic and risk averse. So he suggested the implementation of a strategy of cooperation within the organization so that the people will receive the benefits of teamwork. Matthew and Sternberg (2006) on the other hand proposed deliberate steps that will lead to organizational innovation that in turn would lead to collaboration.
There are those who suggested in bringing the concepts about integration and collaboration to whole new levels. Aside from shirking, and laziness another major cause of inefficiency is the stubborn and deliberate protection of turf. Senior manager and other veterans in the workplace will do everything in their power to secure tenure and therefore seeks to weaken the chances of others to succeed. Collaboration and integration helps create a culture within the organization that says success is not a result of individualistic effort but a consequence of teamwork. In this regard Jassawalla and Sashittal (2006) enumerate the general steps to increase collaboration among workers:
a) find ways to encourage cross-functional communication;
b) adopt features of flattened and customer-focused organizational design;
c) experiment with structural arrangements including liaison roles to improve coordination and cooperation among participants;
d) cross-train key employees and reward people for creativity and cooperation with others (p. 3).
John Nash a product of Princeton University’s mathematics department and Institute for Advanced Studies was able to prove that strategic alliances is much better than individual efforts. Nash was able to prove that, “…collaboration can maximize the joint interest whilst avoiding the worst possible individual payoffs. In other words, competition does not inevitably generate the best possible outcome” (see de Rond, 2003, p. 16).
This insight is very crucial for this study because as shown earlier an agent is oftentimes forced by circumstances to think for himself and not consider the welfare of the whole organization. The agent is forced to compete against the principal because a casual look at the forces arrayed against him will make him conclude that he is at odds with the principal running the firm. For instance, “An agent is likely to have his own distinct interests – oftentimes financial – which he may illegitimately seek to advance at the expense of the principal’s interests” (Bazerman & Watkins, 2004, p. 108).
The ensuing conflict will pit agent against the principal and instead of collaborating the two factions will compete with each other. The consequence of such actions as shown earlier is an organisation that is unable to reach its full potential and possibly low growth.
An example of how non-collaboration is affecting the quality and success rate of the organization was illustrated by Steve Jobs, CEO of the world renowned Apple, Inc. and he is quoted as saying:
You know how you see a show car, and it’s really cool, and then four years later you see the production car and it sucks? And you go, ‘What happened? They had it! They had it in the palm of their hands! […] What happened was, the designer came up with this really great idea. Then they take it to the engineers and the engineers go, ‘Nah, we can’t do that. That’s impossible.’ And so it gets a lot worse. Then they take it to the manufacturing people and they go, ‘We can’t build that!’ And it gets a lot worse (as cited from Jassawalla & Shashittal, 2006, p. 4).
Coming from someone who was successful in designing and building equipment that revolutionised the way people use computers and portable music equipment surely means that Steve Jobs know a thing or two about the power of collaboration – that two heads are better than one.
Applying Solutions to Thales UK
Before discussing the possible solutions to the problem of Thales UK it is important to understand that the principal-agent dynamic described in the case study is a variation of the employer-employee dynamic. Here the employer is Thales UK and the employees are the senior software engineers.
At the start of the employment there is already a generally understood agreement or “contract” between Thales UK and the senior software engineer that all employees must do everything they can to ensure the continued success of the firm. This includes not only turning in exceptional work that would surely satisfy customers but also in the creation of a deep talent pool that will increase the marketability of Thales UK.
When the discussion has reached the point of enhancing the capabilities of all employees here is the also the point where the interest of the employer (Thales UK) and the employee (senior software engineers) began to diverge. The senior engineers does not see the logic of helping the up and coming junior engineers for they are perceived as a threat to the current status and privileges enjoyed by the current crop of senior engineers.
By shirking from the responsibility of training the newcomers the senior engineers is cutting off the capability of the firm to get more contracts. Aside from that the organization is lacking the serious talent in solving more complex problems as mentioned earlier two heads are better than one.
Another thing that has to be considered here is the relative difficulty for the principal to detect the problem. It is a common observation in agency theory analysis that a typical organization – in the way that it was set-up – decreases the ability of the principal to know the details of the operation. This deliberate disregard for the charge to train the junior engineers is a serious problem but one that is hidden from view.
Therefore the first step in creation of the solution is to educate the managers directly responsible for the work teams comprising of senior and junior engineers that such a problem does exist.
By knowing that a phenomenon such as a principal-agent problem is present in the department, the manager can now create checks and balances and other monitoring tools to find out how senior managers are deliberately trying to sabotage the training process or the internship process put in place by the top managers of Thales UK.
Now, this monitoring tool must be used in conjunction with other schemes to minimize shirking. One of the ideas put forward is to find out the amount of salary that should be given to the senior software engineers to make them feel that they could not get the same amount from other firms. By doing so the senior engineers will realize that the present employer is the best option. So when the monitoring tool gives a negative feedback and the senior engineer is warned of a possible termination of employment, the senior engineer will then realize the opportunity cost of transferring to another company.
Another way of solving the principal-agent dilemma is to create a way of educating the senior managers as to the negative outcomes when he chooses to evade work and not provide exemplary inputs. The senor engineer must realize that the “markets” will be the one to punish him from doing sloppy work. By “markets’ the proponent is talking about the labour market which deals harshly with managers and employees who has a reputation of poor quality work.
Now the refusal of the senior engineers to upgrade the company by increasing the number of talented people on board will reduce the number of projects that could be accepted by Thales and this could mean lower profits.
Aside from the decrease in the number of clients that would be streaming to Thales the low number of competent programmers and systems designer will create poor performance overall. As discussed earlier there is so much power and creativity unleashed when all minds are working together in synergy.
This study will be concluded using the words of the popular proponent of agency theory. Michael Jansen after 20 years of teaching the subject made the following assertions concerning the central proposition of the agency theory:
… is not that people are self-interested, or that conflict exist. The central proposition of the agency theory is that rational self interested people always have incentives to reduce or control conflicts of interest so as to reduce the losses these conflicts engender. They can then share the gains. Moreover, the theory provides a general structure to point the way to a variety of classes of solutions to these problems (p. 49).
It is very clear based on the discussion above that shirking is detrimental to both principal and agent. The sooner both parties realize this insight the more they would collaborate in eliminating the problem. It was clearly demonstrated that being individualistic will not allow both parties to be successful in the long run.
The challenge here is that the problems concerning agency theory lies beneath the surface. It is almost impossible for the principal to detect anomalies and weakness in the system. The current workplace is set-up in such a way that it is very difficult for the principal to know everything that is going on in the firm. It is both practical and detrimental to allow managers or agents to have freedom in decision making and use of resources the way they see fit in order for the firm to run continuously.
Various solutions has been proposed but it is the mixture of stricter monitoring tools, incentives that agents will not be able to pass up and organisational innovations that would allow for collaboration and synergy that could well help solve the dilemma as seen in the principal-agent problem.
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