Although there is no miraculous panacea, there are three main tools for dealing with the agency problem:

  • Increasing disclosure requirements reduces the informational asymmetry between the agent and the principal, limiting managers’ ability to prioritise their own selfish goals.
  • Creating a close relationship between company performance and directors’ remuneration. Their compensation package could be a function of the profits generated. Alternatively, directors could receive part of their compensation in stocks or call options, which would align their incentives with the shareholders’ objectives.
  • The introduction of corporate governance rules could, to some extent, force directors to act in the best interest of the company.

The area of corporate governance is defined as the rules that govern how the directors interact with each other inside the company for effective management and handle the directors’ interactions with the shareholders’ desired direction.

The components of corporate governance include:

  • The directors’ remuneration.
  • The accountability of the executive directors’ decisions.
  • The role of the non-executive directors as a check to the executive directors’ power.
  • The representation of small investors interest perceived as powerless.

Even though corporate governance allows to align the manager and shareholders’ interests, some criticism has been raised, proposing to evaluate the directors’ performance based on metrics comparable with peer companies or accounting measures such as share earnings or the return on equity.