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Agency relationship exists when one or more persons (the principal) hire another person (the
agent) to perform some tasks on his or their behalf. The principal will delegate some decision making
authority to the agent. The problems of agency relationships occur when there is a
conflict of interest (or lack of goal congruence) between the principal and the agent. The
relationship can be explained as follows:
a) Shareholders and Managers
The relationship between shareholder and manager may clearly be described as one of
agency. This is so because shareholders appoint managers to run the company on their
behalf.
Unless managers are themselves major shareholders, their interests may not coincide
with those of the firm?s owners. Examples of possible conflicts include:
i) Managers might not work industriously to maximize shareholders wealth if they
feel that they will not fairly share in the benefits of their labor.
ii) There might be little incentive for managers to undertake significant creative
activities including looking for profitable new projects (ventures) or developing
new technology.
iii) Managers might pursue projects which they find personally satisfying at the
expense of other projects offering a better return to the company.
iv) Managers might award themselves high salaries (or executive packages) than
what the shareholders would consider to be justified.
In order to try to ensure that managers act in the best interests of shareholders, the
shareholders incur agency costs such as:
i) Cost of monitoring management activities (e.g. audit fee)
ii) Cost of structuring corporate organization to minimize undesirable
management actions (e.g. internal controls).
iii) Pegging managers remuneration to the success of the firm. Such remuneration
schemes might include:
- Profit based salaries and bonuses
- Share option schemes
- Performance shares
iv) In addition, the threat of firing can also be seen as an incentive for efficient
management as is the possibility of job loss if a company?s share
price through management action is low and a take-over occurs.
marto answered the question on February 12, 2019 at 09:18
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