Agency Problem – threats facing SMEs and possible solutions to control the problem

The resignation of Cecilia Abena Dapaah, former Minister of Sanitation and Water Resources, has kept me thinking on a very interesting topic I learnt during my MBA programme. The topic has to do with the ‘Agency Problem’.

In case you might be the only stranger in Ghana, it was widely reported in the dailies and other social media platforms that two of Ms. Dapaah’s house-helps allegedly stole significant amounts of money and valuable items from her residence in Accra. How could anyone guess that a respected politician like Ms. Cecilia employing two house-helps could cause her to resign from her post?

This article does not intend to discuss the issue in court, neither does it intend to call out who is at fault or otherwise.  I just want to bring to the fore this common threat facing Small and Medium Enterprises (SMEs) and suggest possible ways to mitigate and control this canker called ‘The Agency Problem’!

What is the Agency Problem?

The agency problem refers to the conflicts of interests which arise when goals of the principal (employers) diverge from those of the agent (employees). The agency problem typically arises in situations where individuals or entities delegate a whole or part of their decision-making power, thereby giving authority for employees to act on their behalf.  It manifests when employers hire employees to perform specific duties and responsibilities.

While the employer seeks to maximise business value and profits, the employee may prioritise personal interests such as job security, accumulation of wealth (increase in salary) and career advancement among others. This misalignment can lead to deterioration in the quality of work, stealing from the organisation, misuse of the company’s resources, decrease in productivity and ultimately job losses.

Why the Agency Problem occurs

Although not anticipated, some root-causes of the agency problem which happen during the working relationship between an employer and employee are as follows:

• Inadequate supervision
• Inadequate motivation/Remuneration
• Too much trust
• Greediness
• Focus on making profit to the detriment of employee welfare
• Neglect of employee-welfare at the altar of profit-making
• Stealing, among others

Threats of the ‘Agency Problem’

1. Job insecurity and unemployment: When people who are employed by their employers prioritise their personal interest over the organisation’s long-term success, this can result in job insecurity. If employees engage in funny behaviour that undermines the company’s performance, such as shirking responsibilities or engaging in unethical practices, employers may be forced to downsize or lay-off the employees. Some people who are concerned about these problems feel reluctant in employing others to manage their business. In addition, those who are already employed are fired easily with or without any benefits. Therefore, it was no surprise that the former Minister of Sanitation opted for legal action against the house-helps.
2. Decreased productivity and inefficiency: When employees act in their own self-interest, it often leads to a decline in productivity and inefficiency. For example, when an employee is solely focused on meeting individual targets or securing personal rewards rather than pursuing the organisational interest, they neglect teamwork, collaboration and the organisation’s overall success. This normally decreases productivity and available resources in terms of quantity, quality and timing.
3. Talent management challenges: The agency problem also possess challenges for employers concerning talent management. The pursuit of personal interests by employees undermines organisational goals, making it difficult for employers to attract and retain top talent. Due to this, retaining competent employees becomes difficult. As a result, most SMEs and individual business owners struggle to maintain their staff for a long period. This negatively affects the sustainability of a business and may lead to productivity losses.

Addressing the agency problem

To mitigate the agency problem’s impact on employment, both employers and employees must take proactive measures such as:

1. Effective communication: Establishing clear lines of communication and setting shared objectives can help align goals of the employer with the employee to enhance understanding and collaboration. This involves clearly understanding each other and not overlooking non-verbal communications. Employers and individuals who engage people to work for them must be interested in the ideas and thoughts expressed by their employees. This involves developing active listening skills as well as taking notice of non-verbal communication cues. I am quite sure that with effective communication certain self-fulfilling red flags can easily be detected.
2. Incentive Structures: Incentives are rewards and benefits used to motivate positive behaviour and performance in the workplace. Introducing incentive schemes to reward employees directly or indirectly can align the interests of employees to those of their employers in an organisation. Performance-based bonuses, recognition programmes, career development opportunities can motivate employees’ contribution to the company’s success.

According to Erika Andersen, a well-known business thinker and author: “Leaders have a moral obligation to establish an environment of mutual benefit with their employees – to create a fair exchange of value and realise that it is morally wrong to attempt to get as much from your employees as possible while giving them as little as possible”. However, the rewards and benefits to employees must be linked to performance.   

3. Ethical Standard and Accountability: SMEs and individual business owners should establish ethical standards and guidelines to hold employees accountable for their actions. This may be documented and shared among key stakeholders. Implementing a code of conduct and robust monitoring mechanisms can promote ethical behaviour and, especially, discourage stealing at the workplace. This when implemented effectively will minimise the inherent risk associated with allowing job discretions. I am confident that the brouhaha surrounding Ms. Cecilia and the house-helps would not have arisen if there had been compliance with proper ethical standards and guidelines.
4. Terms of Contract: Terms of contract define each party’s obligations, rights and responsibilities. The parties, in this instance the employer and employee, should ensure that both understand their responsibilities. The terms of contract should as well have a witness’ signature to ensure the document is valid and enforceable. Unfortunately, most small and medium business engagements are only based on word of mouth; there are no written agreements. For instance, when available the agreements are not legally structured. I recommend that a legal practitioner should be engaged to draft contracts.
5. Security Consciousness: Security consciousness simply means identifying and anticipating possible actions and behaviour in people that are not normal and can likely create harm to the environment or organisation. In most cases at our various work environment, privileged information and valuable resources are inadvertently shared with unauthorised persons. Both employees and third parties are given unfettered access to information and resources without proper guidelines.

 

Going forward, employers should limit access or place restrictions on the use of certain types of information and valuable resources. Records of people who visit our workplace for personal and official purposes should be made at all times. In addition, employers should intentionally conduct independent background checks and periodically monitor the social media activities of employees. Apart from these, other technological and pre-security controls may be considered depending on the business’s size and resources.

6. Assets Verification: Asset verification and inventory inspection are important to ensure that assets and logistics placed under the care of employees remain protected and effectively managed. The asset verification exercise should be regularly conducted to ensure all assets in the organisation are accurately recorded and accounted for. In situations where the employer does not have the requisite skill to conduct the asset verification and inventory inspection, the services of an accountant or auditor may be engaged to ensure that the assets truly exist.
7. Encourage the use of e-commerce/electronic payments: As a means of promoting cashless transactions and preventing stealing and pilfering that is normally characteristic with SMEs, employers should institute a cashless system wherein physical cash for payments is minimised if not totally eliminated. Employers should intentionally introduce electronic payment systems as formally acceptable means of payment. Transport owners like Yango, Uber, Bolt should encourage passengers to pay their fares using mobile money accounts. The Ghana Universal QR Code may also be used for payment of goods and services. One key advantage of this electronic payment system is that it is cost-effective.
8. Practice Transparency: Practicing transparency is being open in sharing information, and honest and accountable at all levels. In an employer-employee relationship, both should demonstrate trust and honesty on an individual and business level. This will help mitigate the root-cause of unethical and illegal activities which arises in the business. It is noticed that where there is openness on all matters regarding the decision-making process, employees collaborate with employers to ensure better business performance.
9. Perform Periodic Audits: The employer should ensure there are periodic financial audits conducted to give the owner assurance that financial transactions are properly maintained. In addition, a continuous performance review of the business ensures that all functional areas – such as operations, projects and programmes of the organisation – are reviewed to ensure resources are used economically, efficiently and effectively.

The employer should as well occasionally call for lifestyle audits in cases where it suspects an employee of fraud or notices any disjoint between the employees’ standard of living as against known income source. One good thing about this lifestyle audit is that it probes unexplained wealth and is able to detect conflicts of interest.

Conclusion

Businesses once created must survive all threats, particularly those posed by the agency problem. All stakeholders, including employers and employees, must adhere to these proactive measures to address challenges associated with the employer – employee work relationship.

It is obvious that no business can survive if there is lack of transparency, waste of resources and absence of accountability, non-safeguarding of business properties, absence of contractual agreements, job insecurity and an environment wherein employees are unsatisfied/unmotivated. It is therefore important to consider these best practices for our mutual interests and benefits.

>>>the writer is a Business Coach with over 10 experience in Internal Auditing and Executive Director of Expert Skills Development Centre. He can be reached on 0506082542/[email protected]

 

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