Agency and Conflicts of Interest

8/19/2019 Agency and Conflicts of Interest

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6 7e!ining Agency 8on!licts

6 3anagers, Shareholders, and Bondholders

6 8on!licts Between 3anagers and Shareholders

6 8on!licts o! nterest Between Shareholders and Bondholders

Agency and 8on!licts o! nterest

Introduction to the Field and Goals of Financia... > Agency and Conicts of Interest


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6 The agency view o! the corporation posits that the decision rights ?control@ o! the

corporation are entrusted to the manager to act in shareholders interests. 8ontrolsystems in corporate governance can help align managers incentives with those

o! shareholders and other stakeholders.

6 The principalagent problem concerns the di!!iculties in motivating one party ?the

CagentC@, to act on behal! o! another ?the CprincipalC@. The two parties have

di!!erent interests and asymmetric in!ormation. 3oral ha&ard and con!lict o!

interest may thus arise.

6 The deviation !rom the principals interest by the agent is called Cagency costs. C

Agency costs mainly arise due to contracting costs and the divergence o! control,separation o! ownership and control, and the di!!erent ob)ectives ?rather than

shareholder ma#imi&ation@ o! the managers.

6 3uch recent interest in corporate governance is concerned with mitigation o! the

con!licts o! interests between stakeholders. These occur when an individual or

organi&ation is involved in multiple interests that may lead to con!licts in their

ability to act in the best interest o! one party.

7e!ining Agency 8on!licts


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8on!lict o! nterest

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6 Three parties key to the !unctioning o! the corporation are the managers,

shareholders, and bondholders. %hile managers control the corporation andmake strategic decisions, shareholders are owners, and bondholders are

creditors.

6 %hile all three parties have an interest, whether direct or indirect, in the !inancial

per!ormance o! the corporation, each o! the three parties has di!!erent rights and

rewards, !or e#ample voting rights and !orms o! !inancial return.

6 Shareholders, managers, and bondholders have di!!erent ob)ectives. For

e#ample, shareholders have an incentive to take riskier pro)ects than

bondholders do and may pre!er that the company pay more out in dividends.3anagers may also be shareholders or pre!er risk+averse, empire+building

pro)ects.

3anagers, Shareholders, and Bondholders


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%orking on Assignments



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6 The agency view o! the corporation suggests that the decision rights o! the

corporation should be entrusted to a manager to act in shareholders interests. Agency costs mainly occur when ownership is separated, or when managers

have ob)ectives other than shareholder value ma#imi&ation.

6 Typically, the 8H4 and other top e#ecutives are responsible !or making decisions

about high+level policy and strategy. Shareholders, on the other hand, are

individuals or institutions that legally own shares o! corporation stock.

Shareholders typically concede control rights to managers.

6 There are various con!licts o! interest that can impact managers decisions to act

in shareholders interests. 3anagement may, !or e#ample, buy other companiesto e#pand power. enturing onto !raud, they may even manipulate !inancial

!igures to optimi&e bonuses and stock+price+related options.

6 8ontemporary discussions o! corporate governance argue that corporations

should respect the rights o! shareholders and help shareholders to e#ercise those

rights. 7isclosure and transparency are intimately intertwined with these goals.

8on!licts Between 3anagers and Shareholders


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6 The shareholders are individuals or institutions that legally own shares o! stock in

the corporation, while the bondholders are the !irms creditors. The two partieshave di!!erent relationships to the company, accompanied by di!!erent rights and

!inancial returns.

6 Stockholders have an incentive to take riskier pro)ects than bondholders do.

4ther con!licts o! interest can stem !rom the !act that bonds o!ten have a de!ined

term, or maturity, a!ter which the bond is redeemed, whereas stocks may be

outstanding inde!initely but can also be sold at any point.

6 Bondholders may put contracts in place prohibiting management !rom taking on

very risky pro)ects or may raise the interest rate demanded, increasing the cost o!capital !or the company. 8onversely, shareholder pre!erences++!or e#ample !or

riskier growth strategies++can adversely impact bondholders.

8on!licts o! nterest Between Shareholders and Bondholders


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%all Street bull



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Appendi#


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5ey terms

6 agent 4ne who acts !or, or in the place o!, another ?the principal@, by authority !rom him one intrusted with the business o!

another a substitute a deputy a !actor.

6 bond A documentary obligation to pay a sum or to per!orm a contract a debenture.

6 bond A documentary obligation to pay a sum or to per!orm a contract a debenture.

6 dividend A pro rata payment o! money by a company to its shareholders, usually made periodically ?e.g., *uarterly or annually@.

6 maturity 7ate when payment is due.

6 moral ha&ard The prospect that a party insulated !rom risk may behave di!!erently !rom the way it would behave i! it were !ully

e#posed to the risk.

6 moral ha&ard The prospect that a party insulated !rom risk may behave di!!erently !rom the way it would behave i! it were !ullye#posed to the risk.

6 principal 4ne who directs another ?the agent@ to act on oneMs behal!.

6 shareholder 4ne who owns shares o! stock.

6 shareholder 4ne who owns shares o! stock.


Introduction to the Field and Goals of Financia...


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%orking on Assignments


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8on!lict o! nterest

rincipal+agent problems + which arise when managers act on the behal! o! a ! irm and its investors + include potential con!licts o! interest.


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Two Businessmen Javing a 7iscussion

These two businessmen could represent a manager and shareholder discussing the operation o! the business.


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%all Street bull

The bull on %all Street is an iconic image o! the Oew $ork Stock H#change.


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%hich o! the !ollowing is O4T an e#ample o! an agency cost9

A@ 3anagement buys a subsidiary to e#pand its personal power insteado! ma#imi&ing the companys value.

B@ Hmployees are paid an hourly wage.

8@ 3anagement is compensated with stock options in the company.

7@ Auditing a companys !inancial statements to prevent !raud.

d i h i ld d l f i i


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%hich o! the !ollowing is O4T an e#ample o! an agency cost9

A@ 3anagement buys a subsidiary to e#pand its personal power insteado! ma#imi&ing the companys value.

B@ Hmployees are paid an hourly wage.

8@ 3anagement is compensated with stock options in the company.

7@ Auditing a companys !inancial statements to prevent !raud.

I t d ti t th Fi ld d G l f Fi i

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%hich o! the !ollowing is a source o! agency costs in anorgani&ation.

A@ The managers o! the organi&ation have di!!erent ob)ectives than theother shareholders.

B@ The people who make the day+to+day decisions are not the owners.

8@ arties associated with the organi&ation have di!!erent riskpre!erences.

7@ All o! these answers.

I t d ti t th Fi ld d G l f Fi i


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%hich o! the !ollowing is a source o! agency costs in anorgani&ation.

A@ The managers o! the organi&ation have di!!erent ob)ectives than theother shareholders.

B@ The people who make the day+to+day decisions are not the owners.

8@ arties associated with the organi&ation have di!!erent riskpre!erences.

7@ All o! these answers.

Introduction to the Field and Goals of Financia



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A manager enters into a transaction that bene!its himsel! morethan his shareholders. This is an e#ample o! ::::.

A@ !raud.

B@ contracting costs.

8@ corporate governance.

7@ sel!+dealing.



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A manager enters into a transaction that bene!its himsel! morethan his shareholders. This is an e#ample o! ::::.

A@ !raud.

B@ contracting costs.

8@ corporate governance.

7@ sel!+dealing.




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%hich o! the !ollowing is a !actor that contributes to the con!lict o!interest between a companys bondholders and its shareholders9

A@ Shareholders have a vote in how the company conducts its businessbondholders generally do not.

B@ Shareholders are only paid i! the company makes a pro!it,

bondholders are paid regardless.

8@ All o! these answers

7@ Shareholders generally want the company to pursue riskier pro)ectsbondholders do not.



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%hich o! the !ollowing is a !actor that contributes to the con!lict o!interest between a companys bondholders and its shareholders9

A@ Shareholders have a vote in how the company conducts its businessbondholders generally do not.

B@ Shareholders are only paid i! the company makes a pro!it,

bondholders are paid regardless.

8@ All o! these answers

7@ Shareholders generally want the company to pursue riskier pro)ectsbondholders do not.




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Attribution

6 Wikipedia. CFinancial capital.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Financial:capital

6 Wikipedia. C8on!lict o! interest.C 88 B$+SA .( http-//en.wikipedia.org/wiki/8on!lict:o!:interest

6 Wikipedia. CBondholder.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Bondholder

6 Wikipedia. C8eo.C 88 B$+SA .( http-//en.wikipedia.org/wiki/8eo

6 Wikipedia. C8orporate governance.C 88 B$+SA .( http-//en.wikipedia.org/wiki/8orporate:governance

6 Wikipedia. CShareholder.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Shareholder

6 Wikipedia. Crincipal agent.C 88 B$+SA .( http-//en.wikipedia.org/wiki/rincipal:agent

6 Wikipedia. CAgency costs.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Agency:costs

6 Wiktionary. Cmoral ha&ard.C 88 B$+SA .( http-//en.wiktionary.org/wiki/moral1ha&ard

6 Wiktionary. Cbond.C 88 B$+SA .( http-//en.wiktionary.org/wiki/bond

6 Wiktionary. Cdividend.C 88 B$+SA .( http-//en.wiktionary.org/wiki/dividend




6 Wikipedia. C8eo.C 88 B$+SA .( http-//en.wikipedia.org/wiki/8eo






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6 Wiktionary. Cshareholder.C 88 B$+SA .( http-//en.wiktionary.org/wiki/shareholder


6 Wikipedia. CLoan covenant.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Loan:covenant

6 Wikipedia. CFinancial capital.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Financial:capital



6 Wikipedia. CBondholder.C 88 B$+SA .( http-//en.wikipedia.org/wiki/Bondholder



6 Wiktionary. Cmaturity.C 88 B$+SA .( http-//en.wiktionary.org/wiki/maturity6 Wiktionary. Cshareholder.C 88 B$+SA .( http-//en.wiktionary.org/wiki/shareholder

6 Wiktionary. Cbond.C 88 B$+SA .( http-//en.wiktionary.org/wiki/bond





6 Wiktionary. Cmoral ha&ard.C 88 B$+SA .( http-//en.wiktionary.org/wiki/moral1ha&ard

6 Wiktionary. Cagent.C 88 B$+SA .( http-//en.wiktionary.org/wiki/agent

6 Wiktionary. Cprincipal.C 88 B$+SA .( http-//en.wiktionary.org/wiki/principal

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Agency and Conflicts of Interest