The agency problem: when the person deciding is not the person carrying the risk
The agency problem is the question corporate law was built around. Whoever takes the decisions in a company is not necessarily the person who loses if the decision is wrong. This page explains where the gap arises, which tools the law puts against it, and what can be done in the articles and the agreement before it detonates.
“Oversight mechanisms are not built because there is suspicion. They are built because the interests are not the same.”
Adv. Erez Sapir
What the agency problem is
An agency problem arises whenever one person takes decisions on behalf of another, their interests are not identical, and the decider does not bear the full consequence. In a company that is the normal state: the manager manages, the shareholders fund, and the loss falls mainly on whoever funded.
The problem is not necessarily dishonesty. Even a perfectly honest manager operates under incentives that differ from those of the shareholders. A manager rewarded for growth will prefer growth even where it is risky. A manager close to retirement will prefer stability even where it forgoes an opportunity. Both are loyal to the company as they understand it, and both produce a gap.
Why this matters practically: almost every mechanism you know in company law, from the duty of loyalty to disclosure and approval requirements, was built to narrow that gap. Understanding the problem explains why the rules look the way they do.
Source: Companies Law, 5759-1999. Checked September 2026.
The three arenas in which it appears
Shareholders against management. The classic arena. Management holds the information and controls the day to day, the shareholders hold the money. The gap is chiefly an information gap.
Majority against minority. Here the agent is the controlling shareholder, who dictates decisions while the minority bears the consequence without influence. This is the agency problem in its most painful private company form, and it leads directly to minority shareholder oppression.
Shareholders against creditors. The arena people forget. As a company nears insolvency, shareholders have an incentive to take high risk, because they are already under water and the additional loss falls on creditors. This is exactly where section 6 of the Companies Law comes in, speaking of unreasonable risk taking relative to the ability to pay debts.
Source: Companies Law, 5759-1999. Checked September 2026.
The tools the law provides
The Companies Law does not try to eliminate the gap. It prices it in duties.
Section 252, duty of care. Requires an office holder to act with the skill of a reasonable office holder in the same position and circumstances. It is aimed at the quality of the process.
Section 254, duty of loyalty. Requires acting in good faith for the benefit of the company, avoiding conflicts of interest, refraining from competing with the company, and not appropriating a business opportunity of the company. This is the direct answer to the agency problem.
Section 193, fairness duty of a controlling shareholder. Addresses the majority against minority version, imposing a standard higher than good faith.
Section 192, duties of shareholders. Good faith and customary conduct towards the company and the other shareholders, and a prohibition on abuse of power.
Alongside the duties stand the process tools: disclosure, approval by someone not tainted, and documentation. These are not formalities. They are the mechanism that lets a gap be spotted before it materialises.
Source: Companies Law, 5759-1999. Checked September 2026.
Signs the gap is working against you
For a shareholder outside the day to day, these are the signals worth noticing:
Reports arriving late, in pieces, or only on request; management expenses growing faster than revenue; transactions with suppliers connected to the manager or the controller; material decisions learned about after the fact; a meeting that never convenes; and the answer that is operational, it does not concern you to substantive questions.
No single signal proves anything. An accumulation of them is a pattern, and that is what gets examined afterwards.
Contractual and structural tools
A written information right. Fixed dates for delivery of reports, and a mechanism for requesting more. This is the cheapest and most effective tool, because most of the gap is an information gap.
A right to appoint a director. Presence in the room where decisions are taken, not only at the meeting that ratifies them.
A veto over a closed list. Allotment of shares, related party transactions, borrowing above a threshold, sale of a material asset, change in the field of activity.
A procedure for approving related party transactions. Advance disclosure, approval by someone not tainted, and documentation.
An exit mechanism. Where the gap cannot be bridged, an agreed exit is worth more than any litigation. See the mechanisms on the partnership agreement page.
Pay, and the trap inside it
The intuitive answer to the agency problem is to align incentives: tie the manager pay to company performance, through options or a bonus. It works, and it creates a new problem.
Pay tied to a short term outcome incentivises short term decisions. Options incentivise risk taking, because the upside belongs to the holder while the downside is capped. A bonus on revenue rather than profit incentivises selling at any price.
The conclusion is not to abandon variable pay but to match the metric to the period you actually want to reward, and to include a long term component such as staged vesting. And to remember that setting pay for a controlling shareholder who is also a manager is precisely a related party transaction, with all the disclosure and approval that entails.
The agency problem in a small company
In a company of two or three people it is tempting to think the problem does not exist, because everyone is inside. In fact it simply takes a different shape: one works in the business full time and the other only invested. The first draws a salary, the second depends on a dividend. The first decides, the second hears about it.
That is exactly the structure of the agency problem, and at this scale it is more dangerous, because there is no board, no committees and no third party to balance it. The only tool is what was written in advance.
Three clauses cover most cases: a dividend distribution policy; a cap on remuneration for shareholders who work in the company, or a mechanism for approving it; and an information right with fixed dates.
Legal support
We build the documents that narrow the gap before it surfaces: a shareholders agreement with information and veto rights, a procedure for approving related party transactions, and a pay structure matched to the horizon the company actually operates on. Where the gap has already materialised, we start from what was documented, because that determines what can be argued.
To reach us: 02-5953322 in Jerusalem, 03-3030430 in Tel Aviv, WhatsApp 050-4411343.
Frequently asked questions about the agency problem
What is the agency problem in plain terms?
Does the agency problem assume the manager is dishonest?
Which sections of the law address it?
Do share options solve it?
I am a shareholder who does not work in the company. What matters most to anchor?
Does the problem exist in a company of two partners?
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