...what extent is it true that as a result of agency costs shareholders wealth will not be maximized by corporate management. If so, what actions can shareholders take to correct the situation? As we know that agency costs exists in most corporations since the separation of ownership and management in large businesses. Shareholders are the principals and owners; managers are the stockholders’ agents. The problem is to get between shareholders and managers since they have different objectives. Shareholders’ goals are maximizing firms’ value, managers’ goals are benefit themselves, thus the conflicts rise in the company. In this report through concept of agency costs and analysis that two questions will be discussed. First, to what extent that as a result of agency costs shareholders wealth will not be maximized by corporate management. I will talk the agency costs in the conflict of interest between shareholders and management through analysis and lots of examples. Second I will discuss the actions that shareholders take to reduce the agency costs, and achieve their wealth maximizing. According to Hickman (1996), there are always separation of ownership and management in large businesses. Major corporations may have a large number of shareholder, these shareholders have no way to be actively involved in management so that they hire professional managers to manage the corporations. Shareholders put their money in corporations because they hope that...
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...relationship." When a conflict of interest between the needs of the principal and those of the agent arises, the conflict is called an "agency problem." In financial markets, agency problems occur between the stockholders (principal) and corporate managers (agents). While the stockholders call on the managers to take care of the company, the managers may look to their own needs first. In finance, there are two primary agency relationships: * Managers and stockholders * Managers and creditors PROBLEMS BTW STOCKHOLDERS versus MANAGER and STOCKHOLDERS versus CREDITORS... 1. Stockholders versus Managers * If the manager owns less than 100% of the firm's common stock, a potential agency problem between mangers and stockholders exists. * Managers may make decisions that conflict with the best interests of the shareholders. For example, managers may grow their firms to escape a takeover attempt to increase their own job security. However, a takeover may be in the shareholders' best interest 2. Stockholders versus Creditors * Creditors decide to loan money to a corporation based on the riskiness of the company, its capital structure and its potential capital structure. All of these factors will affect the company's potential cash flow, which is a creditors' main concern. * Stockholders, however, have control of such decisions through the managers. * Since stockholders will make decisions based on their best interests, a potential. *...
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...incentive conflicts exist in corporations? In any corporation one will find conflicts between the managers and shareholders. A major reason behind this fact is that mangers often own very few shares in the company. According to Robert Vishny, who sampled 371 Fortune 500 companies, a firm’s performance is in fact weaker “at low levels of management ownership”. His article goes on to explain that when managers own 5 to 20 percent performance levels are higher when compared with firms where management ownership is only 0 to 5 percent.² Managers, especially those that own very little of the company’s stock, have different goals and motives from those of the shareholders. Manager’s engage in “self-interested behavior”, which is defined as “maximizing their own utility at the expense of corporate shareholders”.³ They very often take fewer risks than shareholders would like in an attempt to increase job security, or they feel they deserve special perks, such as company jets, free lunches, or gym memberships, to name a few. Managers may also shirk on the job instead of work hard and give it their all. While shareholders would like manager’s to maximize value of the firm, managers are more concerned with increasing the size of the firm to make themselves look better. Shareholders are concerned with performance of the company as a whole; mangers are concerned with their own individual performance. Incentives and compensation packages are ways to ease these conflicts, but again...
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...2. Explain several dimensions of the shareholder-principal conflict with manager-agents known as the principal-agent problem. To mitigate agency problems between senior executives and shareholders, should the compensation committee of the board devote more to executive salary and bonus (cash compensation) or more to long-term incentives? Why? What role does each type of pay play in motivating managers? There are several dimensions to the principal-agent conflict. Principal-Agent Relationships exist whenever one person or party works in the interests of another party. The owner (the principal) hires and often delegates decision-making authority to professional managers (the agent) to perform tasks on his behalf. The challenge for the principal is to create an environment in which the agent has incentives to align their interests with those of the principal. The principal typically creates incentives for agents to act as the principal wants. The principal-agent conflict acerbates when the incentive system creates a conflict of interest, the principal cannot ensure the agent is performing exactly the way the principal would like and due to the intrinsic unobserved managerial effort and the presence of random disturbances in team production. The lack of information shared between the two makes it impossible and expensive for the principal to monitor the decisions and performance of the agent. The agent usually has less to lose than the principal; therefore they often seek...
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...CHAPTER 1 AN OVERVIEW OF FINANCIAL MANAGEMENT (Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: Firm organization Answer: c Diff: E [i]. Which of the following statements is true? a. One of the benefits of incorporating your business is that you become entitled to receive unlimited liability. b. Sole proprietorships are subject to more regulations than corporations. c. Sole proprietorships do not have to pay corporate tax. d. All of the statements above are correct. e. None of the statements above is correct. Firm organization Answer: c Diff: E [ii]. Which of the following statements is most correct? a. One of the advantages of the corporate form of organization is that there is no double taxation. b. The partnership form of organization has easy transferability of ownership. c. One of the disadvantages of the sole proprietorship form of organi-zation is that there is unlimited liability. d. Statements b and c are correct. e. None of the statements above is correct. Firm organization Answer: a Diff: E [iii]. Which of the following statements is most correct? a. One advantage of forming a corporation is that you have limited liability. b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of being a sole proprietor is that you have to pay corporate taxes, even though you don’t realize...
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...of Financial Manager can broadly be divided into two: The Routine functions and the Managerial Functions. Managerial Finance Functions Require skilful planning, control and execution of financial activities. There are four important managerial finance functions. These are: a) Investment of Long-term asset-mix decisions These decisions (also referred to as capital budgeting decisions) relates to the allocation of funds among investment projects. They refer to the firm’s decision to commit current funds to the purchase of fixed assets in expectation of future cash inflows from these projects. Investment proposals are evaluated in terms of both risk and expected return. Investment decisions also relates to recommitting funds when an old asset becomes less productive. This is referred to as replacement decision. b) Financing decisions Financing decision refers to the decision on the sources of funds to finance investment projects. The finance manager must decide the proportion of equity and debt. The mix of debt and equity affects the firm’s cost of financing as well as the financial risk. This will further be discussed under the risk return trade-off. c) Division of earnings decision The finance manager must decide whether the firm should distribute all profits to the shareholders, retain them, or distribute a portion and retain a portion. The earnings must also be distributed to other providers of funds such as preference shareholder, and debt providers...
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...'Agency Problem': 14 Investopedia explains 'Agency Problem': 14 Agency Relationship and Agency Costs: 14 Conclusion: 23 Agency Problems Are Mitigated by Good Systems of Corporate Governance 23 Legal and Regulatory Requirements: 23 Compensation Plans: 24 Board of Directors: 24 Monitoring: 25 Takeovers: 25 Shareholder Pressure: 25 OECD Definition of Corporate Governance: "OECD defines corporate governance as follows: “Procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation – such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision-making." Financial Times Definition of Corporate Governance: "How a company is managed in terms of the institutional systems and protocols meant to ensure accountability and sound ethics. The concept encompasses a variety of issues, including the disclosure of information to shareholders and board members, the remuneration of senior executives, potential conflicts of interest among managers and directors, supervisory structures, etc." Cadbury Report Definition of...
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...Agency Conflicts: An agency relationship arises whenever someone, called a principal, hires someone else called an agent, to perform some service, and the principal delegated decisions making authority to the agent. In companies, the primary agency relationships are between: 1. Conflicts between stockholders and creditors 2. Conflicts between Inside Owner/Managers and outside owners 3. Conflicts between managers and shareholders Conflicts between stockholders and creditors Conflict between shareholders and creditors is common for the company which use debt capital to form an optimum capital structure. As mentioned earlier, agency relation exist when one party works as an agent of the principal. In an organization management works as a agent of owner or share holders. When managers work for the company they can be influenced by the own interest so that they prefer their own interest rather than the interest of the company, on the other hand creditors interest is to provide credit and get the principal amount and interest timely. For ensuring their credit return creditor always concerned whether the company is doing business in the right manner or not. By monitoring the financial performance of the company creditors actually want to ensure their interest. So if there is any dispersion then creditors works to resolve the issue by taking necessary steps. Creditors have a claim on part of the firm’s earnings stream as well as a claim on the firm’s assets in the event...
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...1950’s. The meal tray was heated in the oven and consisted of a small portion of meat, two vegetables and dessert. The top two competing manufacturers of microwavable low-calorie foods are Lean Cuisine owned by Nestle and Healthy Choice owned by ConAgra. Both leaders in the frozen food market began in the 80’s. Healthy Choice works rigorously with the FDA to assure foods qualify under government health standards for healthy low calorie foods. Like all businesses these two businesses need a financial business plan that allows them to assess the company’s results and set targets for future growth. Marketing is a vital part of the business plan. Healthy low calorie microwave food as a health option is a concept which has gained enormous interest. The previous assignment discussed the background and the introduction of the company which caters to this segment. The purpose of this paper is to discuss the long term capital budgeting decisions that a company needs to make to determine the market structure operates in and to provide a framework to represent how market makes long term decision. One of the most important long...
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...ownership is separated from management. Managers may be tempted to achieve their own objectives instead of the financial objective. We explore these problems in the discussion which follows. Agency theory says that a company is not a single, unified entity. It calls into question the claim that all of the stakeholders in the company (shareholders, managers and creditors) have a single goal – value creation. Agency theory shows how, on the contrary, their interests may differ and some decisions (related to borrowing, for example) or how products (stock options) come out of attempts to achieve convergence between the interests of managers and shareholders to protect creditors. It analyses the consequences of certain financial decisions in terms of risk, profitability and, more generally, the interests of the various parties. Agency theory is the intellectual basis of corporate governance. Agency theory says that a company is not a single, unified entity. It considers a company to be a legal arrangement that is the culmination of a complex process in which the conflicting objectives of individuals, some of whom may represent other organisations, are resolved by means of a set of contractual relationships. On this basis, a company’s behaviour can be compared to that of a market, insofar as it is the result of a complex balancing process. Taken individually, the various stakeholders in the company have their own objectives and interests that may not necessarily be spontaneously ...
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...Is there a conflict between "doing well" and "doing good"? When there are conflicts, how may government regulations or laws tilt the firm toward doing good? As the text notes, the first step in doing well is doing good by your customers. Businesses cannot prosper for long if they do not provide to their customers the products and services they desire. In addition, reputation effects often make it in the firm's own interest to act ethically toward its business partners and employees since the firm's ability to make deals and to hire skilled labor depends on its reputation for dealing fairly. In some circumstances, when firms have incentives to act in a manner inconsistent with the public interest, taxes or fees can align private and public interests. For example, taxes or fees charged on pollution make it more costly for firms to pollute, thereby affecting the firm's decisions regarding activities that cause pollution. Other "incentives" used by governments to align private interests with public interests include legislation to provide for worker safety and product or consumer safety, building code requirements enforced by local governments, and pollution and gasoline mileage requirements imposed on automobile manufacturers. AACSB: Ethics Blooms: Analysis Difficulty: 2 Medium Learning Objective: 01-06 Explain why value maximization is not inconsistent with ethical behavior. Topic: Understanding the Corporation Is value maximization always ethical? Modern...
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...Chapter 1 The Financial Manager and the Firm Learning Objectives 1. Identify the key financial decisions facing the financial manager of any business firm. 2. Identify the basic forms of business organization used in the United States, and review their respective strengths and weaknesses. 3. Describe the typical organization of the financial function in a large corporation. 4. Explain why maximizing the current value of the firm’s stock price is the appropriate goal for management. 5. Discuss how agency conflicts affect the goal of maximizing stockholder wealth. 6. Explain why ethics is an appropriate topic in the study of corporate finance. I. Chapter Outline 1.1 The Role of the Financial Manager A. It’s All about Cash Flows • The financial manager is responsible for making decisions that are in the best interest of the firm’s owners. • A firm generates cash flows by selling the goods and services produced by its productive assets and human capital. After meeting its obligations, the firm can pay the remaining cash, called residual cash flows, to the owners as a cash dividend, or it can keep the money and reinvest the cash in the business. • A firm is unprofitable when it fails to generate sufficient cash flows to pay operating expenses, creditors, and taxes. Firms that are unprofitable over time will be forced into bankruptcy by their creditors. In bankruptcy, the company will be reorganized, or the company’s...
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...maximizing an organization’s net present value, the allocation of scarce capital resources between competing opportunities and the implementation and monitoring of the chosen strategy so as to achieve stated objectives”. In order to understand what Strategic Financial Management is about, it is necessary to know the meaning of the two words ‘strategy’ and ‘strategic’ as provided by Oxford Advanced Learner’s Dictionary, 6th edition. Strategy: This is the process of planning something or carrying out a plan in a skilful way. STRATEGIC FINANCIAL MANAGEMENT Strategic: This is done as part of a plan that is meant to achieve a particular purpose. If the above definitions are used as a guide, the strategic financial management can be defined, as those aspects of the overall strategic plan of an organization that concern the financial managers. For example, there are many aspects of a business plan (to be discussed later under Corporate Strategy): marketing and sales plan, production plan, personnel plan, capital expenditure plan, etc. All these plans have far-reaching financial implications for the financial managers of an organization as they will be expressed in financial terms for the purpose of evaluating the overall performance of the organization; which, itself, is measured in financial terms. There are two broad categories of strategic decisions that are normally made by financial managers of an organization: (a) the most appropriate level and...
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...v10n1p204 Abstract As the corporative company type emerged, the two functions of ownership and management are separated. In the companies with a large number of employees the managers are the ones that manage the capital in the best interest of the shareholders. In this type of companies, conflict of interest may occur between the managers and the shareholders. Having more information about the work of the company, managers may use it in making decisions for their own benefit, which on the other hand cannot be as beneficial for the shareholders. Conflict of interest between managers and shareholders leads to so-called agency problem. There are different ways by which shareholders can control the operations of management. Some of the measures that can be used to resolve and prevent this problem are subject of analysis in this paper. Keywords: management, ownership, shareholders, conflict of interest, asymmetrical information, corporate governance 1. Introduction It has long been known that in the large companies the interest of the managers may be different from the shareholders profit maximization goal. In these companies mangers are appointed by the shareholders to make decisions and act within their interests. Lasher (2008) says that this kind of relationship creates a conflict of interest...
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...Unit 1 Assignment 1 1. Finance: The science that describes the management, creation and study of money, banking, credit, investments, assets and liabilities. Finance consists of financial systems, which include the public, private and government spaces, and the study of finance and financial instruments, which can relate to countless assets and liabilities. Some prefer to divide finance into three distinct categories: public finance, corporate finance and personal finance. All three of which would contain many sub-categories. Financial Management: The planning, directing, monitoring, organizing, and controlling of the monetary resources of an organization. Finance can be broken into three different sub-categories: public finance, corporate finance and personal finance 2. There are three basic forms of business ownership, namely the sole proprietorship, the partnership and the corporation. ADVANTAGES OF SOLE PROPRIETORSHIPS: Ease of starting and ending the business, Being your own boss, Pride of ownership. Leaving a legacy Retention of company profits. No special taxes. DISADVANTAGES OF SOLE PROPRIETORSHIPS. UNLIMITED LIABILITY Limited financial resources. Management difficulties. Overwhelming time commitment. Few fringe benefits. Limited growth. Limited life span. ADVANTAGES OF PARTNERSHIPS. ...
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