The principal–agent problem occurs when person or firm (the agent) makes decisions on behalf of, or that impact upon, another person (the principal). This dilemma exists in circumstances where the agent is motivated to act in his own best interests, which are contrary to those of the principal, and is an example of moral hazard. The real estate sector is rife with so-called agency problems in brokerage, property management, appraisal etc. and good governance is central to ensuring that such conflicts of interest are identified and monitored.
The Guardian today has a good piece on the use of management consultants. It’s referring to a programme on BBC 2 tomorrow that looks like it may be worth watching for anyone tempted to use management consultants. It’s a sore point at Reading and PwC feature a lot in the article. The Guardian piece quotes from an experienced management consultant, David Craig who points to the modus operandi of some management consultants.
“Very few organisations need a complete overhaul; they need sensible tweaks. But this, Craig says, doesn’t sound dramatic. That’s why you hear consultants refer continuously to “transformation programmes”. Once we’ve taken them into the valley of death, it’s time for salvation. Now we go to the sunny uplands: it’s bad, it’s really bad, but working together we can save the situation. It’ll only cost you two or three million, or maybe you need to buy a computer system for another 50 million. This strategy of finding things to fix once you’ve got your foot in the door is known in the trade as “land and expand”. “You start to uncover issues in an organisation and put them under pressure,” says John Bennett, a former management consultant to the public sector. But is this cynical or just good business?
I can think of a number of high profile governance failures have also occurred in the commercial real estate investment sector. Early in the 2000s, the so-called ‘ Frankfurt real estate scandal’ involved a whole range of problems including systematic bribery of fund managers by real estate developers, architects and construction companies in order to obtain contracts and/or buy buildings on corrupt terms. For instance, buyers and sellers of real estate assets were found to have engaged the services of real estate agents after a sale was completed and to have then split the agent’s fee among themselves. It was also suggested that bribes were paid among fund management organizations to corruptly influence the outcome and level of bids in sales transactions. In 2007-8 in the Netherlands, the Philips pension fund was investigated by the Dutch regulator. Sixteen real estate professionals were arrested and accused of being involved in an illegal scheme believed to have cost the Philips pension fund millions of Euros. The investigation focused on fraudulent real estate transactions involving internal asset managers agreeing relatively low values for assets with external valuers, before properties was sold to business connections. The properties was then later ‘flipped’ for the market value, with the price difference being divided between the participants. Of course, these examples are fairly extreme. I hear whispers of murky practices in the investment agency world. However, most of it is fairly subtle and far from illegal.
Of course there are controls on such behaviour – personal morality, fear of being caught (and consequent losses to reputation and repeat business). However, notorious examples in consumer finance (e.g. insurance, mortgage and pensions mis-selling in the UK), global investment banking (e.g. LIBOR rate fixing, biased stock advice during the dot.com bubble, money laundering) accounting and auditing practices (e.g. Arthur Anderson), corporate malpractices (e.g. Enron and WorldCom in the US, Olympus in Japan) would suggest that many of us are prone to self-serving actions – albeit to varying degrees.