Enron Debacle Example of "Agency Problem" Within Boards of Directors, Say Strategic-Management Researchers

Corporate boards may have disincentives to act in shareholders' best interest

Release Date: January 23, 2002 This content is archived.


BUFFALO, N.Y -- The fall of Enron demonstrates that an inherent management problem previously thought to occur only among a company's top managers also occurs within a company's board of directors, according to two strategic-management researchers at the University at Buffalo School of Management.

In Enron's case, the existence of the "agency problem" within its board of directors is partly to blame for the company's mismanagement and apparent unethical behavior, say John Stephan and Harold Star, assistant professors of management science and systems, who are researching the role of boards and CEOs in setting corporate strategy.

"The agency problem states that because top managers are typically not owners of a company, they can't be trusted to act in the best interest of those who do own the company -- the shareholders," says Stephan. "Boards of directors were seen as a solution to the agency problem because they have a legal responsibility to protect and serve the shareholders.

"But what the Enron case illustrates is that the agency problem also exists within a company's board of directors," Stephan adds. "Boards, too, have incentives not to act in the best interest of shareholders."

According to Stephan and Star, the agency problem at Enron and other companies often is created because the CEO also serves as chairman of the company's board of directors.

"When the chairman is the CEO, then the nature of information that goes to the board is often distorted," says Star. "Making matters worse, the CEO typically stacks the board with cronies and supporters.

"As a result, the oversight role of the board is very easily co-opted into a rubber stamp role," he adds. "That was the case at Enron."

According to Stephan and Star, the Enron case should prompt a lot of re-thinking about the role of the board of directors and whether it's better or worse for a board to own shares of a company.

"The general feeling has been that board members should own shares if they are to represent the shareholders," says Stephan. "But what we're learning from Enron is that when board members own shares, there's a disincentive to ask the really tough questions for fear that those questions will drive down the stock prices."

Adds Star, "The scary thing about Enron isn't Enron. It's that Enron may be just the tip of the iceberg. There are lots of companies who have boards that are closing their eyes to some pretty shady practices."

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