Principal-Agent Theory for Business Strategy

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When the company experiences difficulties in the HR sphere, which touch upon the marketing performance in general and the quality of performed job in particular, the essential redesign o the organizational structure is required. Moreover, the reward system should also be subjected to modifications, as it is the main force, which encourages workers to the fruitful, effective and high-quality work. Originally, the Principal-Agent theory is one of the most relevant for the issues of restructuring, as it presupposes the restructuring and further improvement of the relations between employer and workers, basing on the principle of interest conflict, which encourages both improve the quality of the performed job.

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Organizational Redesign

To begin with, it should be stated that Hospitality Corp is a company, which has been applying the traditional schemes of business performance for a long time.

  • Hospitality Corp (HC) is one of the world’s largest hotelling and resort chains, with more than 3000 hotels and 45 resorts in over 70 countries around the globe.

Organizational redesign, which is required for the successful performance will have to touch the allover structure of management-employee relations, departmental performance, and the providing of the services to customers (visitors). Anyway, the main focus should be placed on the organization itself.

  • Each hotel or resort employs about 30 to 40 staff and is headed by a hotel manager responsible for supervising the employees at the location and for all operational decisions at the respective location (e.g. allocation of employees to certain tasks, training of employees, maintenance of equipment and rooms).

Taking into consideration that there are only two types of problems, associated with Principal-Agent relations, there is a strong necessity to emphasize that the solution of the organizational problem will be related to the factors of information flows within the organization. The problems are the following: problems when the agents perform some actions to improve the allover performance of the job, nevertheless the principals do not observe these efforts, and problems when there are several types of agents and principals, nevertheless, their direct assignments and differences are unknown. (Mcwilliams and David, 345)

The factors of the informational flow, which should be taken into consideration will be the following:

  • The type and quality of the information, which top management gains from the customers, suppliers and partners (how the information is gathered, and how it is processed and interacted)
  • How the information flows through the business structure (who has and who does not have the access to it, how the info is used for making business decisions, and how it is stored)
  • Whether the business performance reflects the information flow (Knox and Blankmeyer, 191)

In the light of these considerations, it should be stated that the organizational structure of HC should be based on the principle of three essentials: Fast, Factual and Frequent.

One of the main aims of the organizational restructuring should be the increase the involvement of the top and front-line managers (who directly deal with the visitors) and staff, engaged in the service sphere in the decision-making process. It has been emphasized, that the traditional business scheme which was subjected to minor modifications, and the Principal-Agent relations should not be so easily structured.

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  • Development slowed down, and performance deteriorated. Today, even though still a leading firm in its business from the number of locations and employees, its financial performance has dropped strongly below market average.

An important factor in restructuring the organization is the clear definition of the control span, which managers and supervisors should have. As Cantwell (562) emphasizes in his research:

The span of control, or span of management, refers to the number of persons who report to one superior and includes the functions of planning, organizing and leading. The span of management has a direct bearing on the number of levels in an organization, which is a measure of the length of that organization’s lines of communications. There are several factors to consider in establishing a reasonable span of control for managers. In addition, the span of control affects the attitudes and behavior of the organizational members.

In the light of this notion, it should be emphasized that the restructuring of the organizational performance should be started from the modification of the information flow system on the managerial level.

Performance Measurement

The next step of organizational restructuring is the modification or complete change of the systems of success measurement. The fact is that the flat salaries, which the workers are paid, neither encourage nor discourage the proper performance of direct assignments.

  • All personnel below the level of the executive committee receive a flat wage based on seniority.
  • Members of the executive committee receive a (higher) fixed salary plus a variable pay based on HC’s overall level of profits as compared to the prior year.

Thus, the fine / bonus system should be implemented into the performance of work assignments. In the light of the fact, that there is a strong necessity to define the working norm, and set the amount of the overtime, or excess norm, which will be extra paid.

  • They are experts in the fields of accounting and reporting, who mostly acquired their knowledge at well-known large firms in manufacturing. The other half is responsible for marketing-related issues like developing and running advertising campaigns.

Taking into consideration the specification of the hotel business, the staff may be evaluated in accordance with several criteria: quality, time and visitors’ satisfaction. On the one hand, visitor’s satisfaction and quality are closely related, nevertheless, they should be regarded as different criteria. (Allan, 376)

The model of measuring performance process should be based on the marketing trends, the business strategy of the organization and financial flow of the company, which is essential for rewarding the staff.

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Strategy perfomance

  • The operation component entails the original quality of the work, physical assets of the activity in the Hospitality Sphere.
  • Finance – is the system of adequate prices for the providing of high-quality services, and the effective reward system, which should entail the basic wages, and the system of fines and bonuses.
  • The market component presupposes the constant analysis of the market in general and evaluating the business activities and marketing strategies implemented by the competitors.
  • Network: is the reputation of the business organization within customers and workers.
  • The organization component entails people, their skills, and the organizational culture of the company.

These components should become the basis of the reward defining principle. As for the mechanism of defining the level of strategy performance as the central component of the success measurement scheme, this may be performed either in the form of surveys or in the form of direct communication with the visitors. Those who have already resorted to the services of the HC, the existing visitors, and potential customers – the target audience of the promos and advertising should be surveyed, and their preferences should be taken into consideration. (Jackson and Randall, 237)

  • Both divisions offer low fair standard accommodation for the mass market as well as superior and premium rooms for demanding customers and have locations spread throughout the world.

As for the matters of Principal-Agent Theory, the fine / bonus system of reward creates the necessary conflict of the interests, which is the basis of this theory; consequently, the principle will be reliable in the context of the regarded problem.

Reward System

Originally, the reward system is regarded as an integral part of the business activity, the essential component of which is the measurement system. Taking into consideration the conclusions of the previous chapter, there is a strong necessity to emphasize that the reward system and performance measurement principles should be properly interconnected, otherwise, both will be absolutely ineffective. Fines and bonuses create the motivation system, aimed at discouraging workers perform low-quality work, and the measurement system defines what should be regarded as low- and high-quality work. The reward system, in its turn, should be regarded as the result of the proper implementation of the performance measurement system.

Nolan Miller identifies the principle of Hidden Information in the context of the Principal-Agent Theory, the reward system. This concept is defined as the properly adjusted information flow system, which is incorporated into the principles of performance and success measurement, and reward system correspondingly. The Hidden Information concept is explained the following:

The essence of the Hidden Information is covered in the fact that managers in companies who take actions that advance their own careers but hurt shareholders, sound like an effort aversion problem with a different definition of effort. Rather than encouraging the agent to undertake a certain action that will more likely lead to good outcomes for the principal, the principal instead wants to discourage the agent from taking certain actions that will more likely lead to bad outcomes for the principal. (Mcwilliams and Van Fleet, 473)

Nevertheless, the application of this concept in real business performance is associated with the increased dissatisfaction of the workers (Agents), as they prefer to know what they are paid for without hidden bonuses or fines.

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Finally, there is a strong necessity to mention that the Principal-Agent Theory may be regarded as the component of successful business strategy, nevertheless, the application of its principles requires the restructuring of organizational structure, implementation of proper success and performance measurement system, and the providing of the corresponding reward system, based on the principles of Principal-Agent theory relations.


Allan, Peter. “Designing and Implementing an Effective Performance Appraisal System.” Review of Business 16.2 (2005): 3

Cantwell, John, Alfonso Gambardella, and Ove Granstrand, eds. The Economics and Management of Business Diversification. New York: Routledge, 2004.

Dalton, Gene W., Paul R. Lawrence, and Jay W. Lorsch, eds. Organizational Structure and Design. Homewood, IL: Richard D. Irwin, 2007.

Hart, Oliver. Firms, Contracts, and Financial Structure. Oxford: Clarendon Press, 2005.

Jackson, Susan E., and Randall S. Schuler. “Understanding Human Resource Management in the Context of Organizations and Their Environments.” Annual Review of Psychology (2004): 237

Knox, Kris Joseph, Eric C. Blankmeyer, and J.R. Stutzman. “Organizational Structure, Performance Quality and Administrative Compensation in Texas Nursing Facilities.” Quarterly Journal of Business and Economics 40.1 (2003): 45

Lord, Robert G., Richard J. Klimoski, and Ruth Kanfer, eds. Emotions in the Workplace: Understanding the Structure and Role of Emotions in Organizational Behavior. San Francisco: Jossey-Bass, 2002.

Mcwilliams, Abagail, David D. Van Fleet, and Patrick M. Wright. “Strategic Management of Human Resources for Global Competitive Advantage.” Journal of Business Strategies 18.1 (2001).

Tata, Jasmine, Sameer Prasad, and Ron Thorn. “The Influence of Organizational Structure on the Effectiveness of TQM Programs.” Journal of Managerial Issues 11.4 (2004): 440

Waiguchu, J. Muruku, Edward Tiagha, and Muroki Mwaura, eds. Management of Organizations: A Handbook. Westport, CT: Quorum Books, 2004

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