We also know that there are mechanisms that can help alleviate agency problems.
A. Audits If the company runs independent assessments or audits, managers can make decisions based on better information, even if their employees are unwilling to provide it. However, many consultants suffer from the same disease as employees: they know that they are most likely to be rehired if they tell the manager what she wants to hear.
B. Truth-Telling Incentives If managers can be rewarded for telling the truth, agency conflicts will become less important. For example, if your company has a research scientist who has expertise in alpha-proteins and works on an alpha-protein project, your goal as manager should be to allow this scientist to say without suffering any negative consequences: “Donot waste your money putting any more research dollars into alpha-proteins.” This means that the scientist’s salary and promotion chances must remain the same or even increase— even if this means that she no longer has a good alternative use for her time and effort. You might even offer a reward for any scientists who are voluntarily cancelling their projects. Would you really be willing to carry through on such a promise? Would your research scientists believe you?
Some companies also undertake post audits, which are designed not only to evaluate the quality of the financial numbers (like a usual audit), but also the quality of managers’ upfront forecasts. Knowing that such post audits will be held will strengthen the incentives of managers to give accurate forecasts to begin with.
C. Contingent Compensation If managers are rewarded more if the project succeeds and punished if the project fails, agency conflicts will become less important. For example, if you pay your managers only when their projects succeed (or throw them into jail when their project fails!), then managers will work harder and choose projects that they believe are more likely to succeed.
Of course, like any other mechanism to control agency problems, this control strategy has its costs, too. Managers have to feed their families and you may not be able to attract the best managers if you force them to take on so much risk. (The capital markets are probably better at taking risk than individual families!) And such managers may also be more reluctant to take good risks on behalf of the company—risks that they should take in the interest of shareholders—if they are themselves risk averse and compensated by outcome.
D. Reputation If managers can build a reputation for truth-telling and capable management, they are less likely to undertake bad projects. For example, agency concerns are likely to be a worse problem when it comes to secret one-shot projects, where your managers cannot build a track record that will help them with future projects. On the other hand, sometimes reputational considerations can themselves become the problem. Witness the many dysfunctional but beautifully artistic office buildings that are primarily monuments to some famous architectural firm.
There is no obvious solution to these decision bias problems. Again, do not believe that just because we have spent only a few posts on agency issues that they are not important—they are both ubiquitous and very important in the real world. As a manager or principal, you must be skeptical of all estimates and judgments and take the biases and incentives of each information provider into account.

We do know where agency problems play a bigger role and where they play a lesser role.
I. Scale and Owner Engagement In a small company with one owner and one employee, agency conflicts are less important than they are in big corporations with their many layers of management and disengaged owners.
Do you believe that professionally run companies really make the best decisions on behalf of their public shareholders? Remember that agency issues do not just arise between shareholders and management—they start with the lowest level employee and bubble all the way up to the top-level CEO. Decision-making is often based on a chain of deception. It is a testament to the importance of sharing risks among many investors that large, publicly traded companies still manage to net-in-net create shareholder value!
II. Project Duration If the project is short-term and/or comes with good interim progress points, it is easier to reward managers appropriately for success and punish them for failure. For example, think how you would judge and reward a manager who is (supposedly) working on an R&D project that is not likely to have visible results for decades. This is a difficult task. Agency problems for large and very long-term projects may be so intrinsically high that they cannot be undertaken.
III. External Noise If good luck is an integral and important part of the project, it becomes more difficult to judge managerial performance, which in turn aggravates agency issues. For example, we can relatively easily measure the productivity of a line worker in a factory. We know whether she works or slacks off. Therefore, agency problems matter less. In contrast, it is more difficult to determine if our sales agent worked hard but the customer just did not bite, or if our sales agent just failed. Similarly, our nightwatch security guard may or may not be working hard, and it could take years before we could learn (probably the hard way) whether she regularly stayed awake or just dozed off.
IV. Opaqueness If information is very difficult for outsiders to come by, agency problems will be worse. For example, if only your manager sees what projects are available, he can present only those that he would like to undertake and not mention those that have higher NPV, but require different skills that he may not have or more work that he finds unpleasant.

Mental biases are not our only bias. Another kind of bias arises when one person is acting on behalf of another. This is called an agency problem—a situation in which the owner of a project has to rely on someone else for information, and this someone else has divergent interests. An example may be shareholders who rely on corporate management to undertake projects on their behalves, or a division manager who has to rely on department managers for information about how profitable their proposed projects really are. A cynical synopsis of agency biases would be “all people act and lie in their own self-interest.” Now, although everyone does have incentives to lie—or at least color the truth—corporations are especially rife with such agency distortions. Of course, few people sit down and contemplate how to best and intentionally lie. Instead, they convince themselves that what is in their best interest is indeed the best route to take. Thus, mental biases often reinforce incentive problems: “wishful thinking” is a disease from which we all suffer.
You can take the fact that we have already had to mention agency issues repeatedly in this blog as an indication of how important and pervasive these are. But, again, lack of space forces us to highlight just a few issues with some examples:
1. Competition for Capital Managers often compete for scarce resources. For example, division managers may want to obtain capital for their projects. A less optimistic but more accurate estimate of the project cash flows may induce headquarters to allocate capital to another division instead. Thus, division managers often end up in a race to make their potential projects appear in the most favorable and profitable light.
2. Employment Concerns Managers and employees do not want to lose their jobs. For example, scientists tend to highlight the potential and downplay the drawbacks of their areas of research. After all, not doing so may cut the project and thereby cost them their jobs.
3. Perks Managers do not like to give up perks. For example, division managers may like to have their own secretaries or even request private airplanes. Thus, they are likely to overstate the usefulness of the project “administrative assistance” or “private plane transportation.”
4. Power Managers typically love to build their own little “empires.” For example, they may want to grow and control their department because bigger departments convey more prestige and because they are a stepping stone to further promotion, either internally or externally. For the same reason, managers often prefer not to maximize profits, but sales.
5. Hidden Slack Managers like the ability to be able to cover up problems that may arise in the future. For example, division managers may want to hide the profitability of their divisions, fearing that headquarters may siphon off “their” profits into other divisions. They may prefer to hide the generated value, feeling that the cash they produced in good times “belongs” to them—and that they are entitled to use it in bad times.
6. Reluctance to Take Risk Managers may hesitate to take on risk. For example, they may not want to take a profitable NPV project, because they can only get fired if it fails—and may not be rewarded enough if it succeeds. A popular saying used to be “no one was ever fired for buying IBM,” although these days Microsoft has taken over IBM’s role.
7. Direct Theft Managers and employees have even been known to steal outright from the company. For example, a night club manager may not ring sales into the cash register. Or a sales agent may “forget” to charge her relatives. In some marginal cases, this can be a fine line. For example, is taking a paper clip from the company or answering a personal e-mail from the company account really theft? In other cases, theft is blatantly obvious. In September 2002, Dennis Kozlowski, former CEO, was charged with looting $600 million from Tyco shareholders. His primary defense was that he did so in broad daylight—with approval from the corporate board that he had helped put in place.