Alan Cring Productions in association with Emergent Light Studio presents
the Illinois State Collegiate Compendium, academic lectures in business and economics.
This is business finance, FIL 341 for Autumn Semester 2024.
Today, the agency dilemma. I have a PowerPoint presentation, it's custom, it's my own,
that is now in your files folder in Canvas, files, PowerPoints, agency.
And that covers what I am doing in this particular lecture today,
but it also spills into the one that I did on Tuesday as well.
And we'll get to that very soon. Just a quick look at the numbers here.
We're having a pretty serious down day right now.
As you can see, let me turn on this projector here.
The Dow is not down too much, down less than three quarters of a percent,
but it gets pretty ugly down here with the S&P 500, it's down 1.65 percent,
and the NASDAQ is down more than two and a half percent.
This is not good news. And it indicates that there is a lot of concern in the markets in general.
And a lot of that has to do with uncertainty.
As you can see there, this is not a pleasant day.
CRUDE has been bouncing around this session.
It's still below $70 a barrel, so that's not much to worry about right there.
But those numbers like that.
Now really quickly here, let me look at the VIX,
which is telling us about current volatility conditions.
And now look at that, it's good green.
That means it's up from yesterday, and it's been having some wavy spikes.
And it's really, there's a lot of uncertainty.
And although politics generally does not enter the stock market too much,
a matter of fact, hardly much at all usually,
this is a really kind of a different situation here today as we move toward the election.
And we'll probably still have this volatility, uncertainty,
going through tomorrow and Monday and also Tuesday
as we shake out which of the candidates for the White House is going to actually prevail.
We just have to wait and see how it plays out.
Once there is, whichever one it is, you will see that volatility calm down.
It's because certainty, this is essentially Schrodinger's cat.
While the cat's in the box, we don't know whether it's alive or dead,
so we have total uncertainty.
But once the box is open and we know what the cat looks like,
well, then other markets are going to say, okay, now we know more,
and so we can move from there and adapt to whatever is going to happen with that new president.
So there you are.
That's where we are looking at right now.
Now let me go back here just quickly.
The most important thing to have a look at is the gold has taken a toilet break.
It's dropped pretty noticeably.
And that's a little surprising because usually gold gets excited,
the gold bugs get excited if there's uncertainty and all of that.
But for some reason, they are taking their profits and leaving the playing field for the day,
whatever that means, and so is silver for that matter.
But the 10-year bond, there was a sell-off last night after the bond market opened,
after this bond thing opened, and sell-off, that was, of course, the price is going down,
yields going up, but something turned the market around.
About a few hours ago, maybe eight or so, nine o'clock, it just turned around.
But suddenly there was a buy and a lot of buy, giving price support,
and so the yields began to come back down.
By the end of the day today, we may have a slight negative, a lowering of that yield there.
Right now it's almost not even worth mentioning.
It's 0.4 basis points.
So right now it's pretty much flat for the day.
And if it keeps falling like this, in other words, if it keeps buying pressure, pushing prices up,
it'll probably go a little negative for the day today.
And then coming over here, you've got the Nikkei.
As usual, it drops in the opening, and then it had another drop, and I think from what I hear,
from what I'm hearing is that was on concerns about North Korea fired an ICBM,
an intercontinental ballistic missile, and it was more or less a successful test.
And that's scaring the crap out of Japan, Korea, and other places in the eastern hemisphere.
And so that seems to have been what caused that drop for a while.
But then, you know, after all is said and done, it's North Korea.
How many of these can they build?
How many nations that they would target wouldn't be able to stop that missile in its flight if they did try to nuke?
Now this ICBM can reach the United States, so that's a concern.
And it's a concern here as well as it is in places like Japan, even Australia.
So, you know, it's going to be a little, that adds a little bit of worry to the markets.
That kind of some case running North Korea has now got a successful way to throw his toys at the rest of the world,
pretty much the whole world.
Although I don't think they are, they're Mark IV, so I don't think they can reach Europe.
But still, they can reach us, and they can reach Japan and South Korea.
So it's a worry, but we hope he's not crazy enough to try to use one,
because we turned his whole country into a parking lot.
But anyway, that's that.
And then London, just a sour day.
It just had a bare day, and there's not much we can say.
It's been having a string of bare days.
There are concerns about the British economy being weak and all of that.
So the market over there is reacting.
What's driving us down?
There have been, I was reading a couple of analysts saying, why the hell is the market dropping like this?
We've got strong numbers.
We just had another report that it looks like inflation is going back down.
It's pretty much what it usually used to be.
So we shouldn't be worried about that.
We've got strong consumer spending going into the holiday season.
It's hard to tell what's going on.
There is a little bit of a blemish right now in the housing market,
and that's housing purchases, house purchases are down.
There is actually, that might mean that, well, it might mean the consumers are worried about the future.
But it also might mean that they are waiting for interest rates on mortgages to fall.
So they're going to back off and see if the interest rates can get, say, down below 5% in the next few months.
So it might not be as bad news as some are making it out to be.
But anyway, why is the market going down so much when the news is almost all positive?
GDP numbers were released yesterday.
We're growing at 2.8%, which is a darn nice sustainable growth rate without inflation.
It looks good.
So hard to tell what's pissing off the markets and consumer sentiment,
even though they're buying like blind trout right now.
They are, consumers are saying, oh, it's just such a blah economy.
It's terrible.
You know, what's going on?
What are they basing this on?
Well, we can't figure it out yet.
So one way or the other, that's where we are.
Now, let me finish up this corporate governance.
And I'm going to take it down the path of agency.
Now, in the last lecture, and of course, I don't have a marker.
Again, give me one second to get a marker, and I'll be right back.
I've got to steal one.
Ah, there we go.
Good.
Yes, we'll walk you around in this room.
Okay.
This is great meat for quizzes and exams,
definitional kinds of questions and all of that.
But I gave you the definition of an agent and a principal.
Well, this marker really isn't doing me any good here.
Let me see if I can find someplace else to steal a marker.
Ah, damn it.
No markers, no markers.
Come on.
Really?
Oh, that's right.
Fuck.
Well, I'll just have to do this on the overhead.
Apologies for that.
Let me get back to this.
Okay.
Let me do this on a Word document,
and then I can just upload the Word document anyway.
So, that's fine.
Word.
Open.
Okay.
Dark mode.
Cool.
So, we're going to make a big font for us to see.
Okay, and then we'll view zoom to page width.
Okay.
Now, as I had said, I gave you the definitions of a principal
and principal.
Really?
I'll get back here.
Principal and an agent.
Now, remember that the agent is the principal is the person
whose wealth or welfare is to be maximized.
And the agent is the person who's charged with maximizing
that principal's welfare.
And that gives you an idea of how these arrangements work.
In fact, so, for example, the doctor is the agent of the patient.
The child is the principal.
And the parent is the agent.
And when we think about it this way,
the board of directors is the agent of the shareholders
of a corporation.
Framing it this way, most contractual arrangements involve,
well, many if not most, involve an agency relationship.
In one way or another, someone is a principal and the other party,
the counterparty, is the agent in these relationships.
And that carries with it a lot of implications.
But before I go on to the main point, the agency dilemma,
I want to stop for a moment and talk about contracts.
And I was a little bit surprised at some of the things
I used to teach business law that were important for business to know.
There's one critical in this lecture,
and it's not taught anywhere anymore,
even though it will bite you in the butt if you don't know what it is.
But starting off, now understand that when I say contracts,
now contracts can be written or they can be oral.
No, not verbal.
Verbal means oral or written.
So contracts can be either.
An oral contract is not defective.
It is not less than a written contract.
That's something that is kind of a myth.
Oh, we want this in writing.
No, oral contracts are just as good.
And in some cases, so for example, if I go in and you are the cashier at McDonald's,
you say, may I McHelp you McPlease?
And I say, McYes.
Now, I should McLike that McBurger up there on your menu board,
and you say, why McCertainly?
A contract has been formed.
It's an oral contract.
There's nothing wrong with it.
It is the most common kind of contract there is.
Now, there's an offeror and an offeree.
Now, the offeror, okay, who's making the offer here?
Are you making the offer?
Is McDonald's making the offer or am I making the offer?
Actually, no.
That sounds crazy, but you are not making the offer because an offer has to be explicit in terms of timing,
the amount, the number of units, and the total value.
You're just putting up an advertisement.
Unless it is very specific, I am the offeror and you are the offeree,
and by saying McYes, McCertainly, then you have accepted my offer.
And then, so that's the first thing, offer and acceptance must be in a contract.
Offer and acceptance.
The second thing is, I'm going to give you money and you're going to give me a burger.
Thing of value for thing of value.
That is crucial to a contract.
Now, think about that one.
It turns out that you, madam, are my daughter.
So I give you a gift of a car.
And then I find out that you've hooked up with a guy named Nick who drives motorcycles and he robs banks.
And I say, well, I'm going to take that car back and you say, no, you aren't fat boy.
And I'm going to say, actually, I've got a contract with you.
You said you would behave and you say, screw you.
You see, the problem with that is that a gift is not a contract.
A gift cannot be.
So if, for example, I offer you an engagement ring, animal,
and then we break off the engagement, I say, you give me that ring back.
And you say, no, bitch, I want that ring back.
You say, no, it was a gift.
There was no thing of value for thing of value involved.
You say, well, I gave you love.
Oh, bullshit.
Quit it.
That's not good enough.
It's not an explicit thing.
There was not a thing of value for a thing of value involved in it.
So it falls apart on a contract right there.
Now, it's still an agreement possibly, but a contract is higher than an agreement.
It's more specific.
Now, the next one is capacity.
Both parties have to be capable.
Generally speaking, a miner cannot be held to a contract.
They can enter a contract, but they can revoke the contract at will.
That's why you don't want to take too many liberties with selling anything to a miner,
because they can invalidate the contract.
In other words, it is voidable.
It is voidable.
And also, one last thing about contracts is they have to be legal.
Their legality has to be involved.
It has to be a legal transaction.
It has to be legal.
So we have offer and acceptance, thing of value for thing of value, capacity, and legality.
Those are the four parts of a contract.
Now, I'm going to make a distinction here, and it sounds a little bit odd, but it's important.
In the Western world and all over the world, we actually see two kinds of law.
Now, in some countries, one law dominates altogether.
In others, the other kind of law dominates.
These two types of law are what are called statutory law, and the other kind is called common law.
Statutory law is law that is written in ink, as it were, or electronic bytes these days.
Thou shalt by this book not do.
That's statutory.
The most biggest example would be Roman law, lex romana, the law of the Romans.
Nothing was left to chance as the Roman Empire proceeded through the early, through the several centuries BCE
and into the post BCE era.
That law book became enormous.
It became insanely burdensome.
There were jokes among lawyers while this guy came to me, and he had a case that he wanted me to help him with.
But his case is on page 1823 paragraph B, and I specialize in paragraph C, so I couldn't help him.
That was how bad it was.
But it was monstrously influential.
Wherever the Roman Empire went, it imposed lex romana, the law of the Romans.
In fact, even after the Roman Empire fell, the Visigoths took the law.
They didn't understand it, and it kind of turned into a giant hodgepodge for a couple of centuries.
But lex romana became lex romana visigothas.
It was that powerful.
So anywhere you go where Rome was hanging around, dominating, there you had it.
Especially if they'd been there for quite a while.
So France, Spain, and a number of other countries, they have statutory law because they got it from the Romans.
To this day, it's statutory law.
In fact, there is one place, one state in the United States that is pure statutory law.
It's Louisiana, because it's basically French, and a lot of delicious food that gives me cramps.
But anyway, so there you have it.
Now the other kind of law is common law.
This is tribal law.
The Germans, the Africans, many in the Asian theater, the Native Americans, and the British,
because they had been populated by the Anglo-Saxons and the Yutis.
And even when the French, and there was a problem.
The French, at the Battle of Hastings, the French won over the Anglo-Saxon forces.
And then the French tried to impose statutory law.
England was common law.
What came out of it was a frickin' mess.
Which came over here to the United States when the crazies in Britain were chased out
and they started colonizing the United States.
So we have a bizarre combination of statutory law and common law here.
You see, common law is the law of the elders.
We decided something many centuries ago.
And over time, you respect what the elders decided.
Now it does have a very slow, it has an ability to adapt.
But it is still based upon this term in Latin.
It's called stare decisis, or decisis.
Stare decisis, respect the precedent.
In other words, we are based on what has been decided before.
So our law is very much involved in that.
There's so much of common law in our books.
So for example, well the Constitution says, actually the Constitution is irrelevant.
What is relevant is constitutional law.
What the courts have decided the Constitution says.
That is what is relevant.
We cannot refer back directly to the Constitution.
That's originalist thinking.
But you want to talk about the body of constitutional law?
It takes up literally petabytes of server space.
All of the common law.
The common law decided by judges, decided by the appellate courts, decided by the Supreme Courts of the United States over the many years.
And that's how it works.
So we have statutory law.
A law will be written, or something will be in the Constitution.
But it has no meaning until it is adjudicated by a court.
Now many are not adjudicated.
We just sit there and say statutory law stands because no one takes it through the court system.
Or the court system says, I don't want to do that.
But ultimately everything is subject to judicial review.
Now that came about, it came early.
The Supreme Court of the United States in I think 1787 took on the case Marbury v. Madison.
And that was where judicial review was established.
The Supreme Court said, no, if there's a law, we get to adjudicate its constitutionality.
That set it so that we would be essentially, statutory law stands until the court decides whether it is constitutional or not.
So there's where we sit.
But the Christian law is important to us because in a lot of our business,
we are facing a kind of combination of statutory law, but also common law is playing in.
And so we have to accept that.
And ultimately, the ultimate law of us in our lives, and especially in business, comes from common law.
And I'll get to that in just a minute here.
And that's why this almost ultimate.
Now what I'm going to get to is a type of duty that's called fiduciary.
Fiduciary duty.
Black's law dictionary says that fiduciary duty is the highest law implied.
Fiduciary duty is the highest implied.
Now when they say implied, that means common law.
It's not written.
States, countries, they'll say, well, this is fiduciary.
So what?
Fiduciary law is deeper.
It is so ancient that we find it in the roots of the first languages in the world, all over the world.
It is that well understood.
We'll get to that in a minute.
But first of all, let me now get you to the agency dilemma.
An agent has incentive to maximize its own welfare instead of that of the principal.
The agent is supposed to maximize the wealth of the principal.
But every agent, every agent has an incentive to take care of itself.
Every agent does.
I don't care if you're the most religious agent on earth, you're the most dutiful, you have the incentive.
And in business, we have to assume that agency dilemma is present.
And it is everywhere.
This incentive to do what's right for yourself instead of what's right for the one you're supposed to take care of.
And in business, this is the operating principle for a good corporate government.
As the late President Ronald Reagan said of nuclear test ban treaties with the Soviet Union, trust but verify.
And in our world, in business, we have to liquidate this.
In other words, turn it into actual dollar value.
So what does that mean?
That means that we have to face costs that are driven by agency.
And there are five of those.
Agency costs.
The first one is perquisites, otherwise known as perks.
Agency costs extracted because of position.
This is the executive who has a desk that you could land small jets on.
This is the C-suite that has a private plane to fly from city to city for their meetings
when they could take Greyhound and they could stay in a Motel 6, would they stay in a five-star Weston.
That's the first one, perquisites, because you have position.
You take.
And that you're taking from the principle.
By taking those, you're spending money that isn't yours.
Well, I need a nice chair for my office.
I'm important. My butt feels better when I decide better.
No, you're taking.
That's an agency cost.
The next one is called shirking.
That is avoiding duties.
Shirking is everywhere.
My favorite example of shirking comes from a consulting job I did some years ago in a place quite a way, long way, long, long way from here.
There was a corporation and I was at dinner one night.
Early on they took me out to dinner and there were different C-suite and some upper middle level managers there.
There were a couple of lower level employees that they always took a few.
It was a nice thing to do.
There was this one upper level middle manager, upper middle level manager, and they were just talking.
He made this comment.
He said, my desk is clear every night.
I get it all done so I can go home and my desk is clear.
Then right away one of these administrative assistants that they brought along, she just leans over to me and she says, yeah, because he takes all the work off his desk and he puts it on his employees, his underlings' desks after they leave.
That's why his desk is clear.
Then we come in in the morning and we have hell to face because we've got to fix everything that he left behind.
That's shirking.
Shirking is, of course, the five minute smoke break that turns into 20 minutes.
Shirking is there was another company.
Every morning there was this one account executive.
He'd come breezing in right on time, 8 o'clock every morning.
He'd sweep past the receptionist desk, grab the Wall Street Journal off her counter, and then he'd go into the executive toilet and he'd shit for 40 minutes.
Literally, we timed him.
Every day.
That man was so regular, he should have been a model for how to go to the toilet every day at the same time.
40 minutes.
But hey, I came in on time.
That's shirking.
Shirking can be subtler, too.
It's when you don't work at a pace as quickly as you could because you just like to take it easy at your job.
That's shirking.
There are all kinds of places shirking happens.
In any event, you are taking from the principles that time is money and you're taking that money away from the owners of the corporation.
Now the next one is direct theft.
Stealing. Just stealing.
Now this is a surprisingly large thing.
I just went upstairs and grabbed myself a couple of pens.
I like the Pilot pens that they have in the storage cabinet in the Department of Finance, Insurance, and Law.
I took three.
I needed one.
But they're nice pens.
Now if you repeat this, I will hunt you down.
That's simple.
But stealing happens all the time.
It happens in many different subtle ways.
A long time ago I was working with some cost control consultants, this husband and wife pair.
They educated me.
I mean it was just amazing the things that you can see that are stolen.
Once they enlightened me and they said watch.
And I thought oh my God.
Things like that.
But that one's.
And then you have lying.
Lying is everywhere.
We all lie.
Most of our lives are white lies.
And they don't hurt anybody per se.
But in the work environment, lying is a surprisingly large problem.
I had a manager.
She said how are you doing on these Excel sheets that I gave you last week?
Well I'm almost done.
Well she just went into his files folder and she found out he was lying.
He hadn't even started.
Lying.
Okay.
Well okay.
The student who says well I'm feeling really sick.
I'm not going to come to class today because I'm sick.
Well sometimes it's true.
Sometimes they're just lying.
They don't want to come to class.
Things like that.
I've had examples.
One time I had a kid whose grandmother died twice during the semester.
He forgot that he had given that excuse before.
And those are, I mean damn your grandma comes back from the dead.
Shit I'd shoot her again.
She's probably a zombie.
Double tap.
But that kind of stuff does happen.
And it is part of you, again, don't assume intentions.
You act on capabilities.
So sometimes I come off like an asshole in the classroom.
No.
I want to see documentation.
I've got Excel certificates.
I want everyone to get certified in Excel in FIL 240.
So what have I got?
I've got certificates that are faked.
I know where they're getting them faked.
And it's kind of easy once you know how to do it to tell them it's a fake cert.
So they're just going to get their hundred points for that term assignment.
And they're not going to do the work.
And you ask them, well did you really do this?
Oh yeah.
Okay.
Now the last one, incompetence.
Have you ever worked with someone who was as dumb as a box of rocks and that is actually disrespecting rocks?
You have to fix their mistakes one over the other after the other.
They're nice people usually.
They're just dumb Fs.
And you're going to have to deal with their mess.
Others will have to clean up what they've done.
Incompetence is actually something that happens all the time.
But a lot of people, there's, many years ago there was a management guru named Dr. Peter.
And he had something called the Peter Principle and he published a book.
And people thought it was just kind of like a joke.
But it's actually, we understood very soon that it wasn't a joke.
You don't have to remember this, but I'm not going to test you on it.
But what he wrote was the Peter Principle.
Every employee rises to his or her level of incompetence.
When you're good at something, you'll rise.
You're good at that, you'll rise.
Until the point where you rise to a position that you cannot do.
And then you'll stay there.
That is pervasive in C-suites.
People who were good when they were at a lower level and they just kept getting promoted until they hit the C-suite and then they can't do it anymore.
Another place where we see it a lot is in sports.
Someone who was a good coach at the high school level and then he was a good coach at the college level,
then a good assistant coach at professional level.
He gets to be the coach at the national level and he sucks.
He is terrible.
He has an O and infinity season one after the other.
We see those all the time.
So incompetence is out there.
Now for the last round.
That agency principle up there, you have to appreciate that it is not the agent's job to monitor and enforce his own behavior.
That is the principal's job.
The principal is what we call the respondeat superior, not the underlings.
This is common law.
It's called vicarious liability.
That will be in your PowerPoint so you don't need to worry about writing it down.
Vicarious liability.
It ends at the top.
It ends at the top at the principal level.
Well, he did that and we told him not to.
Well, it was your job to monitor and enforce.
So the lawsuit is on you, Cupcake, not on him.
That's how it works.
And that's why it is your job as a principal to watch them because it's not their job.
In almost all situations, there's only one situation, one type of agency where that's not true.
In general, it's the principal's job.
But what happens if the agent has, the principal has some fundamental defect that prevents him or her from monitoring and enforcing?
In other words, there's some reason why the principal can't be held.
That's a special kind of relationship.
It's called a fiduciary relationship.
A fiduciary relationship is one where the agent must monitor and enforce on himself.
Think about the child-parent relationship.
The child is the principal, but how is the child supposed to monitor and enforce the performance of the parent?
The doctor-patient relationship.
The patient is the principal, the doctor is the agent.
But how is a patient supposed to know so much about medicine?
There's a fundamental defect in that.
Same with a lawyer.
Lawyer is the agent and the client is the principal.
But the client doesn't know the law.
These are relationships that transcend the normal business environment.
In fact, even the board of directors is in a fiduciary position because the shareholders, yes, they're supposed to monitor and enforce,
and to some extent they can through the voting process every year.
But they can't do it at the granular level.
They're not allowed to go in and watch what the accountants are doing.
They're not allowed to go in and watch what the operations managers are doing.
So there is another fiduciary relationship.
This is the one that, and this is in your PowerPoint.
Black's Law Dictionary says it's the highest duty implied by law.
Fiduciary.
Now fiduciary relationships are characterized by three pillars.
Trust, royalty, and fidelity.
They are the highest of your duties.
A marriage is a fiduciary relationship.
Remember that the partners are the agents.
The marriage is the principal.
But the marriage is just a contract.
It can't monitor and enforce.
Its life depends upon the agents monitoring and enforcing themselves.
The parent and the child relationship depends upon the parent monitoring himself or herself.
The board of directors must monitor and enforce its own behavior.
That's corporate governance.
How do we get a board of directors to monitor and enforce its own highest values in its actions for the shareholders?
How do we get soldiers to take care of, monitor and enforce their own behavior to protect the Constitution?
How do we get the President and the Congress to monitor and enforce their own behaviors to protect and advance the welfare of the citizens?
These are fiduciary relationships.
And you will be in some of these as you get older.
These are the heart and soul of being the good corporate citizen of this 21st century.
And so that's where this lecture ends.
Be that good citizen.
Fiduciary duty was the duty of the Knights, the great Knights of the Medieval period.
They were supposed to protect the Crown even as they were thousands of miles away from the castle.
They protected the Crown and they protected its interests.
Be the Knights of our century.
That's all I have for you.
I thank you.