SOMEONE WISE once said that all the problems of capitalism are agency problems. Agency costs arise when somebody (the principal) delegates a task to somebody else (the agent) and their interests are at odds. In the textbook example, the principal is a manager, the agents are employees. It is in the manager’s interest that the agent works hard. The more effort each worker puts in, the higher the firm’s output and the greater its profits. But the employer cannot gauge the true effort of the workers, especially if the results are a team effort. Each worker has an incentive to shirk.
Asset management has a double agency problem. The first lies with the separation of ownership and control in large public companies. Shareholders are the principals, who delegate running the firm to managers. Shareholders care about returns on their investment, but managers have different goals. They may value perks and prestige—a plush office, a company jet, a high-profile merger deal—more than profits. Running a big company is a complex task. It is hard to be sure if the bosses are making a good fist of it. No individual shareholder has a big enough stake to make the effort of monitoring worthwhile.
Mechanisms have emerged to limit such agency costs. A classic paper published in 1976 by Michael Jensen and William Meckling argued that loading...