Conflicts and Financial Collapse: The Problem of Secondary-Management Agency Costs

Summary

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Corporate governance scholarship has long focused on conflicts of interest between firms and their top executive officers. This Essay contends that increasing leverage and financial complexity make it important for scholars also to focus on conflicts of interest between firms and their secondary managers.

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Conflicts and Financial Collapse: The Problem of Secondary-Management Agency Costs

Introduction

I have recently argued that financial market failures can be attributed, in large part,1 to three causes: conflicts, complacency, and complexity.2 This Essay engages the first cause, focusing on a subset of conflicts that in the past has been regarded as relatively harmless: conflicts between a firm and its middle- to lower-level management (hereinafter "secondary management" or "secondary managers"). The Essay's thesis is that, as financial markets and the securities traded therein become more complex and as firms become more highly leveraged, these conflicts are increasingly likely to trigger the collapse of firms that invest in those securities and possibly also of the markets themselves.

Corporate governance scholarship has long grappled with conflicts of interest between a firm (meaning its owners, typically shareholders) and the firm's top managers, such as chief executive officers. Costs associated with this conflict are referred to as agency costs because managers are agents of the firm. It is widely acknowledged that top managers sometimes act to benefit themselves, to the detriment of the...

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