Trust and Incentives in Agency

The demise of Enron, the largest bankruptcy in United States history, raised fundamental questions about the role of trust in agency relationships. The corporate collapse cast doubts on trust relationships between investors and corporate managers, between investors and investment advisors and accountants, between pension beneficiaries and trustees, and between employers and employees. The events surrounding Enron gave support to arguments that courts and legislators had caused corporate fiduciary law to abandon trust. In this article, we present a general framework for understanding the role of trust in agency relationships. We provide an operational definition of trust that clears up many conflicting interpretations and allows for treatment of diverse types of agency situations, including investor/corporate manager, trustee/beneficiary, attorney/client, and employer/sales agent. Also, we show how different types of governance mechanisms work together to promote trust. Our analysis is of particular interest for corporate governance since as Hansmann and Kraakman point out, three generic agency problems arise in companies as reflected in potential conflicts between (1) owners and managers, (2) majority and minority owners, and (3) between the firm itself and contracting parties such as creditors, employees and customers