Improving fundamental analysis by considering agency problems

Since at least the 1980s, economists have discussed agency problems: when agents such as managers at a company act in their own interest rather than in the interests of their principals, the shareholders. CFA Institute is interested in learning how to address agency problems through better fundamental analysis that measures the costs of these problems (agency costs) and incentivizing managers to pursue an approach that is more fully aligned with the interests of their principals.

CFA Institute first focused on including agency problems in fundamental analysis in 2005 when the issue of “short-termism” was identified. Since that time, other opportunities to improve fundamental analysis have been identified, with environmental, social, and governance (ESG) issues coming to the fore most recently.

2005–2006: Short-termism identified and recommendations issued

In 2005, according to a survey of more than 400 financial executives, 80% of the respondents indicated that they would decrease discretionary spending on such areas as research and development, advertising, maintenance, and hiring to meet short-term earnings targets and more than 50% said they would delay new projects, even if it meant making sacrifices in value creation. [1] This admission that managers were willing to sacrifice long-term investment in favor of short-term gain was alarming.

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