...Arthur Anderson 1. Environment, strategic, organizational changes * High quality accounting, promoting integrity and sound audit opinions over short run profits * 1930’s- government adopted laws that require public companies to submit financial statements to independent auditor each year * mantra- good service, quality audits, well managed staff, profits for firm * auditors rewarded for making sound auditing decisions * decision rights to Professional Standards Group * firm did not become wealthy in the early years, partners were well respected in communities * 1950’s- Joseph Glickauf- computers to automate bookkeeping * 1979-42% of $645m fees came from consulting * 1989- split to AC and AA * accounting business grew slowly in 1990 due to increased competition and mergers * AA adopted new strategy of generating profits, “it was a matter of pride” * New rules- partners retired at 56, less experienced auditors and fewer partners overseeing audits * New breeds of partners- Samek, Allgyer, signing off on inaccurate financial statements * 1997- AC split completely and became Accenture, AA underwent setback when they didn't receive the $14b expected payment from AC * AA- 2X performance evaluation, relaxed dress code, wooden doors removed * New service- take over entire internal bookkeeping for clients- impaired quality of audits * Enron-1986, wholesale energy trading * Anderson hired Enron in 1990 * Speed...
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...Agency theory is based on the assumption that the individuals act to maximize their own expected utilities Relationship between one person (principal) entrusted to another person (the agent) RESIDUAL LOSS *Loss associated with no being able to fully align the intrst of principal with their agent BONDING COSTS *cost borne by the agent as a result of the aligning their interst EG: i)agent prepare the fs(effort & time) ii)Constraints manaher xtvt MONITORING COST *the cost observing & monitoring the agent’s behaviour EG: I )auditing cost ii)Budget restriction iii) Operating rules Agency Costs -due to self interst, the agent may act for their best interest. -Agency problem give rises the agency costs JENSEN & MECKLING (1976) *Contract under which on or more (principals) engage another person (the agent) to perform some service on the principal’s behalf which involves delegating some decision making authority to the agent *Utility maximization by both parties (eg: there is no reason to believe that the agent will always act in the principal’s best interest.) Agency problem -problem of inducing an agent to behave as if he were maximizing the principal’s welfare. Focus on delegation of jobs from principal to the agent AGENCY THEORY POSITIVE -Descriptive, explanatory or predictive -describe how people do behave -largely dismissive NORMATIVE -Prescriptive -prescribe how people (acctnt) should behave to achieve an outcome...
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...Chapter 1: Exercises 2, 3, and 6 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? The dimensions of the principal agent problem are: Principals lack of knowledge, skill, and time than agent. The objective for principal and agent is difficult to align. Normally agent is looking for present value; principal is looking for long term return. Compensations committee should design a salary or bonus formula that can satisfy agent’s expectation. For example, if any investment decreases the present value but increase the long term value that should be considered to manager’s contribution and be reward in a monetary way. Therefore, manager would not radically to seek present value. The salary plays a role of manager’s daily work. The bonus plays a role of manager’s operation performance. Bonus should motivate manager’s decision for long term and short term consideration. 3. Corporate profitability declined by 20 percent from 2008 to 2009. What performance percentage would you use to trigger executive bonuses for that year? Why? What issues would arise with hiring and retaining the best managers? If the corporate profitability...
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...are some reasons for the company not use the shareholder wealth maximization for the decision making. First, the shareholder wealth maximization is a long-term goal, it need time to considering, if a company must use a short time to do the decision making, it may not use the shareholder wealth maximization model. Second, if the manager just want to maximize their own bonuses, they normally consider things based on short term goals which may not be to the benefit of shareholder so that they will not use the shareholder wealth model to consider things. 7. Explain what is meant by agency relationships and agency costs. An agency relationship occurs when one or more individuals (the principals) hire another individual (the agent) to perform a service on behalf of the principals. Two of the most important agency relationships in finance...
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...Agency costs in corporate governance The information asymmetry that exists between shareholders and the Chief Executive Officer is generally considered to be a classic example of a principal–agent problem. The agent (the manager) is working on behalf of the principal (the shareholders), who does not observe the actions, or many of the actions, or is not aware of the repercussions of many of the actions of the agent. Most importantly, even if there was no asymmetric information, the design of the manager's contract would be crucial in order to maintain the relationship between their actions and the interests of shareholders. Information asymmetry contributes to moral hazard and adverse selection problems. Agency costs mainly arise due to contracting costs and the divergence of control, separation of ownership and control and the different objectives (rather than shareholder maximization) the managers. Professor Michael Jensen of the Harvard Business School and the late Professor William Meckling of the Simon School of Business, University of Rochester wrote an influential paper in 1976 titled "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure".[3] Professor Jensen also wrote an important paper with Eugene Fama of University of Chicago titled "Agency Problems and Residual Claims".[4] There are various actors in the field and various objectives that can incur costly correctional behaviour. The various actors are mentioned and their objectives...
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...Chapter 10 - Incentive Conflicts And Contracts CHAPTER 10 INCENTIVE CONFLICTS AND CONTRACTS CHAPTER SUMMARY This chapter provides an overview of incentive conflicts and contracting within firms. It begins by defining the firm as a focal point for a set of contracts. It then discusses the many incentive conflicts that exist between the parties that make up the firm. The role of contracts in reducing these conflicts is examined. The importance of asymmetric information in limiting the ability to solve these problems in a costless manner is stressed. Both postcontractual and precontractual information problems are examined. The role of implicit contracts and reputational concerns in reducing incentive conflicts is discussed. CHAPTER OUTLINE FIRMS Managerial Application—Enforceability of Implicit contracts INCENTIVE CONFLICTS IN FIRMS Owner-Manager Conflicts Choice of effort Perquisite taking Differential risk exposure Managerial Application—The Spectrum of Organizations Differential horizons Overinvestment Other Conflicts Managerial Application—Buyer-Supplier Conflicts Managerial Application—Experimental Evidence on Free-Rider Problems Managerial Application—Incentive Conflicts throughout the World CONTROLLING INCENTIVE PROBLEMS THROUGH CONTRACTS Costless Contracting Managerial Application—Jack Welch’s Perquisites Costly Contracting and Asymmetric Information Managerial Application—Agency Problems with Owner-Managers Postcontractual Information Problems Agency Problems...
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...International Journal of Business and Management; Vol. 10, No. 1; 2015 ISSN 1833-3850 E-ISSN 1833-8119 Published by Canadian Center of Science and Education The Agency Problem: Measures for Its Overcoming Meri Boshkoska1 1 Faculty Economics-Prilep, Republic of Macedonia Correspondence: Meri Boshkoska, Faculty of Economics-Prilep, Republic of Macedonia. E-mail: meribb@yahoo.com Received: September 19, 2014 Accepted: November 4, 2014 Online Published: December 20, 2014 doi:10.5539/ijbm.v10n1p204 URL: http://dx.doi.org/10.5539/ijbm.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...
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...What is Agency Problems When a principal hires an agent to carry out specific tasks, the hiring is termed a "principal-agent relationship," or simply an "agency 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...
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...* MECHANISMS FOR DEALING WITH SHAREHOLDER-MANAGER CONFLICTS * * AGENCY VERSUS CONTRACT * * FURTHER READING: Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely defined) between resource holders. An agency relationship arises whenever one or more individuals, called principals, hire one or more other individuals, called agents, to perform some service and then delegate decision-making authority to the agents. The primary agency relationships in business are those (1) between stockholders and managers and (2) between debtholders and stockholders. These relationships are not necessarily harmonious; indeed, agency theory is concerned with so-called agency conflicts, or conflicts of interest between agents and principals. This has implications for, among other things, corporate governance and business ethics. When agency occurs it also tends to give rise to agency costs, which are expenses incurred in order to sustain an effective agency relationship (e.g., offering management performance bonuses to encourage managers to act in the shareholders' interests). Accordingly, agency theory has emerged as a dominant model in the financial economics literature, and is widely discussed in business ethics texts. Agency theory in a formal sense originated in the early 1970s, but the concepts behind it have a long and varied history. Among the influences are property-rights theories, organization economics, contract law, and political philosophy...
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...the Audit Quality Forum, the current work programme and how to get involved is available at www.icaew.co.uk/auditquality or contact 020 7920 8493. © December 2005 Institute of Chartered Accountants in England & Wales Dissemination of the contents of this paper is encouraged. Please give full acknowledgement of source when reproducing extracts in other published works. No responsibility for any person acting or refraining to act as a result of any material in this document can be accepted by the ICAEW, the Audit and Assurance Faculty or authors. ISBN 1 84152 404 2 AuditQuality a Q Agency theory and the role of audit CONTENTS 3 Contents Page Executive summary Introduction Principal-agent relationships What is an agency relationship? Agency theory Motives of agents and...
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...Enron: Case Study 1 The purpose of this paper is to formally address the Enron scandal that came out in late 2001. It will discuss a brief introduction to how Enron came to be such a large and powerful corporation and the decisions made which resulted in its ultimate downfall. While discussing these time periods, accounting issues such as the agency and horizon problems as well as agency costs and the manner in which they affected Enron will be dissected additionally. Lastly, an analysis of these issues and recommendations given in favor of preventing types of corruption like this will be listed out in detail. The company all starts with Kenneth Lay. Lay received a PhD in economics and was interested well ahead of the industry, in energy deregulation. He was promoted by George Bush Sr. to be named as Deregulations Ambassador at Large (Gibney, 2005). In 1990, Jeff Skilling joined Enron and turned the pipeline company essentially into an “energy bank”. This helped immensely for Enron in terms of establishing themselves as a very powerful corporation. “Enron was quickly transformed from a sleepy cash cow to a darling of Wall Street with a bounty of promising opportunities.” (Stewart, 2006). Enron’s misuse of mark to market accounting became step one of a few crucial mistakes that the company had made. “With a wave of accountants’ magic wands, Enron was authorized to record in a single year all the profit that would normally be booked over 10 to 20-year...
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...the principal, delegates work to another party, the agent who performs that work. In the context of corporation, the agents are the managers and the principals are the shareholders. Agency theory as related to the corporation is set in the context of the separation of ownership and control as described in the work of Berle and Means (1932) Agency relationship Agency relationship is defined by Jensen & Meckling (1976) as a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizes there is good reason to believe that the agent will not always act in the best interests of the principal. Agency cost Agency cost is the principal can limit divergences from his interest by establishing appropriate incentives for the agent and by incurring monitoring costs designed to limit the aberrant activities of the agent. In addition, in some situations it will pay the agent to expand resources to guarantee that he will not take certain actions which would harm the principal or to ensure that the principal will be compensated if he does take such actions. However, it is generally impossible for the principal or the agent at zero cost to ensure that the principal will be make optimal decisions from the principal’s viewpoint. In most agency relationships, the principal and agent will...
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...compensation are classified into four categories: salary, bonus, long-term incentive rewards (e.g., stock options), and benefits. In examining these components, equity based compensation and agency theory were employed and investigated as key factors of analysis. Many academic scholars advocate that the issues of CEO compensation have been a subject of debate and research, due to the agency problem. Thus, for the past three decades, issue of executive compensation was approached from the perspective of the principal-agent relationship. Agency problem, in the context of the five papers mentioned above ‘is the possibility of conflicts of interest between the shareholders and managers of a firm’. According to agency theory, each firm consists of principals (shareholders) and agents (managers). The assumptions of agency theory are that agents are motivated by self-interest, are rational actors, and are risk-averse (Kathleen et al, 1989). Thus, an agency problem exists when an agent such as a CEO has established an agenda that odds with stockholder interests. However, the nature of the conflict between a CEO and shareholders may arise because the CEO’s objectives may not...
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...The Uses and Abuses of Agency Theory in Business Ethics The spectacular corporate scandals and bankruptcies of the past decade have served as a powerful reminder of the risks that are involved in the ownership of enterprise. Unlike other patrons of the firm, owners are residual claimants on its earnings.1 As a result, they have no explicit contract to protect their interests, but rely instead upon formal control of the decision-making apparatus of the firm in order to ensure that their interests are properly respected by managers. In a standard business corporation, it is the shareholders who stand in this relationship to the firm. Yet as the recent wave of corporate scandals has demonstrated once again, it can be extraordinarily difficult for shareholders to exercise effective control of management, or more generally, for the firm to achieve the appropriate alignment of interests between managers and owners. After all, it is shareholders who were the ones most hurt by the scandals at Enron, Tyco, Worldcom, Parmalat, Hollinger, and elsewhere. For every employee at Enron who lost a job, shareholders lost at least US$4 million.2 Furthermore, employees escaped with their human capital largely intact. Creditors and suppliers continue to pick over the bones of the corporation (which still exists, under Chapter 11 bankruptcy protection, and continues to liquidate assets in order to pay off its debts).3 But as far as shareholders are concerned, their investments have simply evaporated...
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...the existence of two groups of people; principals or superiors and agents or subordinates. The principals will delegate decision making authority to the agents and expect them to perform certain functions in return for a reward. Both the principals and the agents are assumed to be rational economic persons motivated solely by self-interest but may differ with respect to preferences, beliefs and information (Jensen and Meckling, 1976). The principal/agent relationship can exist throughout any organisation and usually starts from the shareholder-director and ends with the supervisor-shop floor worker (Figure 1.1). In an organisation context, which involves uncertainty and asymmetric information, the agent’s actions may not always be directed to the best interests of the principal. Agents’ pursuit of their self-interest instead of those of the principal is what is called the agency problem (Jensen and Meckling, 1976). To counter this behaviour, the principal may monitor the agents’ performance through an accounting information system. The owner can also limit such aberrant behaviour by incurring auditing, accounting and monitoring costs and by establishing, also at a cost, an appropriate incentive scheme (Jensen and Meckling, 1976). According to Jensen (1998), agency theory seeks to understand: (1) how to assign decision making responsibility to agents, (2) how to monitor agents’ behaviour, and (3) how to design incentives that cause agents to behave in a way that enhances the...
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