The Use Of Agency Theory To Analyze Problems In Ryanair Company

Ryanair is clearly using agency theory to explain their mistreatment of employees. Agency relationships are agreements under which one party (the principal) engages another person (the agent), to perform some service on his behalf.” (Brickley Smith) In this instance, Michael O’Leary would be considered the principle. Agents would represent the pilots. Ideally, both agents and the principles should have the same incentives. In this case, the pilots/agents had unfair contracts and were required to pay for their training. Ryanair’s image suffered from this lack of compensation.

According to agency theory, Michael O’Leary is trying to maximize profits in order to gain some personal benefit. If certain financial targets are met, O’Leary will be awarded a bonus. Ryanair’s case is clear proof of this. We can conclude that those who are actors within the principle/agent relationship make decisions based on information they know. This information gap can cause firms to be financially vulnerable. This information gap can be costly for firms. Economics is all in the making of tradeoffs. O’Leary chose to sacrifice a customer-friendly working environment and maximize profit. RyanAir could also make this a way to increase customer base. RyanAir explores the idea in a separate paper. “Firms try to signal that its prices are low so that customers will continue to trade with them.” (Kyle Bagwell, 1986).

Ryanair’s failures to comply with agency theory is a clear indication that things must change in order for it to remain competitive in the market. As stated above, if Ryanair is unable to offer pilots better contracts they will search for them elsewhere. This results in cancellations and a loss of money for the airline. But negative publicity will not end.

Ryanair must properly compensate its workforce, or they will be outperformed by their competitors. Ryanair may not see the benefit of paying more money in the short-term but it will help them to build a new image long-term.

Ryanair could invest more money in properly training their pilots as well as flight attendants to ensure that future incidents, such the viral video, are avoided. Ryanair could face a boycott if this happens, and it would cost them millions.

It is obvious that this case study used economic theory to examine the various problems caused by the principal-agent structure. Although agency theory assumes people will act rationally, it is not always true. People sometimes act irrationally to their own advantage. Ariely agrees with this, stating that “irrationality” is the true invisible hand behind human decision-making. In the VW case, it is impossible to determine if the CEO or other managers were acting rationally. Therefore, agency theory solutions are not reliable. Analyzing the VW case using agency theory may yield more precise solutions if we consider behavioural economists, which recognizes that people sometimes act in a rational way.

Agency theory holds that humans are governed by self-interest (Perrow 1986). [3] VW management was motivated to maximize the profits from a ‘green’ car and not take on any production costs. This might make sense in the VW case. However, the assumptions may not be right. Agency theory is based upon the belief that people can be rational, efficient consumers, self-interested and have a fixed preference. As I mentioned, rationality is a problem. However, the main assumptions of the economic model (Hirsch Michaels Friedman) are too simple and unrealistic. It ignores the complexity and inefficiency of organisations, making agency theory too easy.

A possible solution to VW’s problems with agency theory was suggested in the report, which recommended that remuneration policies be aligned with long-term company results. While we suggested stock options instead of bonuses, evidence suggests that this may not solve all the problems. DeFusco, Johnson, and Zorn (1990), show that stock-price volatility can increase and traded bonds prices drop after approvals of executive stock choice plans. Stock options offered to management can also have increased risks. The incentive could be lost if stock prices fall; it is not a solution that solves all problems.

Agency Theory can help to understand the VW case but there are limitations. Eisenhardt (1989). The effectiveness of agency theory research can also be improved if applied to other theories. In the VW example, Conlon, Park (1990) demonstrated that the combination of behavioural economics and institution theory can solve economic problems.