Entrepreneur: Are Your Key Employees After Your Best Interest?

If you are a practicising entrepreneur already, there are two possibilities when it comes to managing your business: 1. you manage your business yourself; 2. you hire somebody to manage it on your behalf. Of course, there are various pros and cons to both choices and that is part of another post. If you are not an experienced manager, you better take the reins as the business’s leader, and let somebody step up in order to do the management (planning, organizing, leading, and controlling–the four functions that define management) part. The moment you hire somebody, you become the PRINCIPAL, and your employee-manager becomes your AGENT, who acts on your behalf.

The big question is: are your agent’s interests aligned with your interests? Does your agent think your interests first before his, or he’s more after saving his own skin. Human nature, let us not expect a ‘Mother Theresa-selfless love for all-kind of thing’ in here. But, whose interests does your agency protect?

In order to see the point clearly, let us look at a real-life example. You are a General Manager of your small business. Essentially, you manage the business yourself. But you need employees to run it; key employees who need to act on your behalf in order to run the business (because obviously, business can’t be run by only one person; and if you’re not yet a practising entrepreneur you should know by now that business is about teamwork). So you hire your COO (chief operations officer, a fancy way of calling your top operations manager), your CFO (chief finance officer, another fancy way of calling your top finance manager), and your CMO (chief marketing officer, or your top Marketing Manager). Say your team is complete. You are the PRINCIPAL, if you own the business, at the same time manages it; your COO, CFO, and CMO are your key AGENTS.

Say you start on a project to boost your sales. Your CMO spearheads it; because he’s a Marketing person, he is in-charge of a Marketing program. You have given him certain budget for Marketing Expenditures. Now… with you as the principal who expects results from your agents, the big conflict may come in, depending on how you measure your expectations. Let us look at three scenarios, under three different incentive schemes

1. If the reward focuses on staying or not on budget. You are invited to highlight your product through a product placement in an indie film that is promising when it comes to the volume of the target market. The cost is not within the budget, but this will bring significant exposure to your brand and possibly sales from huge customers. If your CMO is rewarded by staying on budget, because he is human and he looks after his own interests, would he care to cross the line and make your richer, or he will discard the project and go on budget? You get it right; he would not want to get fired so he will play safe and discard the project, despite the incentive to your business. PRINCIPAL-AGENT conflict.
2. If the reward focuses on achieving or not the results. Say the reward changes, and your CMO is then rewarded by the level of results that he/she is going to achieve, i.e. incremental sales revenue, where leads can be traced from the exposure to the product placement. If your CMO is a rational individual who is driven by incentives vs disincentives, what would he do? If he sees the product placement as something that could accomplish results on his part, he will pursue it. Are your interests aligned? Well, yes, partly. You wish to get richer in profits, he wishes to get a huge bonus by the higher sales. The PRINCIPAL-AGENT interests are somehow aligned.
3. If the reward focuses on taking risks for stellar performance. Let’s make the situation more complicated. Let us say that while the potential return on your investment on the product placement through sales revenue is high, there are huge risks that are associated with the project. Let us say the film is controversial; while it may stir a lot of publicity, it may encounter huge oppositions to certain political parties. If your CMO is being rewarded in the way of situation 2, do you think he would still pursue the project? When there is huge risks associated on the project, and if he is rewarded by the results, would he still look after the high possibilities of revenues? Of course not! He will save his own skin. He would not dare lose his head. Unless you reward him to take some risks, he’s human and he’ll look after himself.

In corporate governance and behavioral finance, we call this the Stakeholder Agency Theory. So, what behaviors do you provide your key employees (AGENTS) incentive? Which behaviors do you reward the most? Isn’t it time to think if your agents are looking after your business and your company’s profitability rather than saving their skin and going after their own job securities? Isn’t it something to think about now, when you assess your business’s performance?

I’ll leave you with that. Just remember, even your most honest employee is human–driven by incentives and disincentives.