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ACC501 GDB Solution Fall 2012

Discussion Question:

Shareholders are considered as the owners of a corporation so “wealth maximization of the shareholders” remains one of the main goals of the corporation. Even so, sometimes there may develop a situation when managers pursue their own goals at the expense of shareholders’ goals. This situation of conflict is termed as “Agency Problem”. In this particular situation, agents (managers) emphasize only those aspects of performance that are related to their own interests by ignoring the interests of principals (shareholders). In order to align the managers’ goals along with the shareholders’ goals, the corporation has to incur some agency costs. You are required to discuss the techniques of aligning the “agent-principal” goals for which the agency costs are generally incurred.

SOLUTION:

Principal –agent conflict arise because managers & shareholders view the role of the corporation differently. Investors see corporation as investment vehicles. Shareholders want corporate managers to work diligently and efficiently towards the simple goal of maximizing the value of their ownership stake. However, the relationship between the managers of a corporation and its owners is complex.

The principle of self-interested behavior tells that people, including managers and stockholders, work in their own financial self interest. This is considered the main source of divergence between a manager’s and an owner’s goals. Each wishes to maximize wealth and benefits, often at the expense of the other party. The modern corporation separates ownership and control giving rise to the principal-agent relationship. However, this separation gives managers an opportunity to work in their own self-interest.

There are six different types of agency conflicts briefed below.

Major source of manager-owner conflict is a behavior called shirking. Shirking is not putting forth the best effort to help stockholders realize the largest return possible. Perhaps managers are spending too much time enjoying perks and creating an opportunity cost of not working on projects and day-to-day operations. Whatever the reason, stockholders’ value decreases each time an opportunity for firm improvement is lost to shirking managers.

Further, managers have different time horizons than the shareholders. The executives concerns largely on their tenure with the corporation, whereas shareholders concerns with value of infinite series of future cash flows.

OR

A conflict arising when people (the agents) entrusted to look after the interests of others (the principals) use the authority or power for their own benefit instead.

It is a pervasive problem and exists in practically every organization whether a business, church, club, or government. Organizations try to solve it by instituting measures such as tough screening processes, incentives for good behavior and punishments for bad behavior, watchdog bodies, and so on but no organization can remedy it completely because the costs of doing so sooner or later outweigh the worth of the results. Also called principal-agent problem or principal-agency problem.

 

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