The agency problem and public employee pensions

Jack Cross, the administrator of PSPRS from 1983 to 2004, has been accused by current PSPRS officials of improperly increasing his own pension (ABC15 Investigates: Former police and fire pension fund manager accused of inflating his own pension).  After an internal audit, Mr. Cross' monthly pension benefit was suspended by officials to recoup an alleged $600,000 in overpayments.  Mr. Cross, who draws his pension through the Elected Officials' Retirement Plan, filed a lawsuit in March 2011 to overturn this suspension and alleges that his benefit should have actually been higher.  Maricopa County Superior Court records show this case is still ongoing.  This shows a classic example of the agency problem.

The agency problem or principal-agent problem describes an inherent dilemma in organizations.  In business the dilemma is between the principal, the owner or stockholders, and the agents, the managers.  While both parties have general common interests such as keeping the business solvent, each party wants to maximize his gain from participation in the relationship.  The agent has multiple interests that includes pay and benefits, power, career advancement, and self-esteem.  The principal is primarily interested in maximizing the return on his investment.  Stock options, employee stock ownership, and profit-sharing are all ways businesses try to align the interests of principals and agents to minimize the agency problem.

While Mr. Cross' alleged transgression makes a perfect business school case study of the agency problem, its impact on PSPRS' finances is small.  The real agency problem  for PSPRS and pensions like it involves public employee unions and politicians.  Representatives of public employee unions act as agents for their members, both current and future.  Politicians are agents for both employees, retirees, and taxpayers.   All the principals have an interest in the pension remaining viable for the indefinite future.

However, the self-interest of union representatives and politicians can vary with their principals.  Union representatives, who are generally the most senior employees and closest to retirement, will necessarily have an interest in maximizing their own retirement benefits to the detriment of more junior members as well as future hires.  Politicians have self-interest in keeping their jobs and will have an incentive to help special interest groups, like public employee unions, who help them stay in office.  Taxpayers, who have a huge, long-term financial stake in PSPRS' operation but are unaware of its problems, have their interests ignored by short-sighted politicians who care only about winning the next election.

This also helps answer the question posed in the prior post about why Stockton used bonds to finance enhanced pension benefits.