AGENCY PROBLEM ANDAGENCY COST

By, Nidhish Thampi P11138

PGDM – A

AGENCY PROBLEM

Agency problem is the likelihood that managers may place personal goals ahead of corporate goals.

A characteristic feature of corporate enterprises is the separation between ownership and management.

Thus, with the objective of survival, management would aim at satisfying instead of maximizing shareholder’s wealth.

Prevention of Agency Problem

The agency problem can be prevented by: Market Forces Agency CostsMarket Forces:It is of two types:Behaviour of security market

participantsHostile Takeovers

Cont’d….

• Behaviour of security market participants: The participants include institutional

investors(mutual funds, insurance etc.) actively participate in management. They use their voting rights to replace more competent management.

• Hostile takeovers: It is the acquisition of the firm by another firm

that is not supported by management. The constant threat of takeover motivate management to work for maximising owner’s wealth.

AGENCY COST

These are the costs borne by shareholders to prevent agency problem as to maximise owners wealth.

They have to incur 4 types of costs:MonitoringBondingOpportunityStructuring

Monitoring Expenditures and Bonding Expenditures

Monitoring the activities of the management to prevent satisfying and maximising owner’ wealth.

It relates to the payment for audit and control procedures to ensure that management is working for maximising owner’s wealth.

Bonding protects the owners from the consequences of dishonest acts by management/managers.

They firm pays to obtain a fidelity bond from a third party bonding company to compensate for financials loses due to dishonest acts.

Opportunity cost andStructuring expenditure

Opportunity costs are those which results from the inability of the firm to respond to new opportunities.

Due to organisational structure, hierarchy etc. the management faces difficulties in seizing profitable investment opportunities.

Structuring expenditure relates to structuring managerial compensation to maximise owner’s wealth.

Cont’d…

It is of two types:1. Incentive Plans2. Performance Plans

Incentive Plans: They tie management compensation to sare

price. The most widely used plan is stock options

which allows management to acquire shares at special prices. Higher price will result in larger management compensation.

Cont’d….

Performance Plans: These plans compensate

management on the basis of its proven performances.

Performance shares are given to management for meeting the stated goals

Another type, cash bonuses – cash payments are given for achievement of the stated performance goals.

Thank you...!!