Agency Problem between Shareholders and Managers | Financial Management
Agency problem is the conflict of interest between the shareholders and managers, and shareholders and creditors. It may cause difficulty in achieving the goal of shareholder’s wealth maximization.
Agency Problem between Shareholders and Managers:
Shareholders can be viewed as active Principals and Managers can be viewed as passive Agents.
Shareholders are the real owners of the company however they cannot actively manage the company themselves as they are in large number and dispersed in various geographical locations and , also they may not have necessary skills ,expertise and experiences to manage a company.
Therefore, they elect a BOD from among themselves for managing the firm. BOD delegates its authority to CEO who is responsible for the management of a company.
Managers are concerned with their personal wealth, prestige, salary, job security, fringe benefits, etc.
It might result potential loss of wealth for the shareholders resulting in the conflict between shareholders and them. Managers may tend to compromise between their own satisfactions in maximizing of shareholder wealth.
The agency problem between then occurs because the management may tend to act for achieving his/her own goals at the expense of other owners.
Since, Managers have much more information about the company they can manipulate the company’s information for their own benefit.
Managers may not work hard for maximizing shareholder’s wealth because only less of the wealth will be given to them.
Managers may sometime tend to give away the corporate earning to their favorite charitable institutions for their glory and personal satisfaction.
Managers may also practice the poison pill( practice where management poses the company as unattractive to be taken over) and greenmail( practice of repurchasing shares from the person trying to gain control of the firm) for preventing hostile takeover.
The agency problem between shareholders and managers arises due to the conflicting interests between these two groups within a corporation.
Shareholders, who own the company, seek to maximize their wealth through the appreciation of stock value and dividends, while managers, hired to run the company, may prioritize their own interests or personal goals over those of the shareholders.
This misalignment of interests can lead to agency costs, such as managerial opportunism, where managers may pursue actions that benefit themselves at the expense of shareholders, or moral hazard, where managers take excessive risks knowing that shareholders bear the consequences.
To mitigate the agency problem, various mechanisms such as executive compensation structures, independent boards of directors, and shareholder activism are employed to align the interests of managers with those of shareholders, ensuring that managerial decisions are made in the best interest of the company’s stakeholders as a whole.
References
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Chen, J. (2022, June 20). Agency Problem: Definition, Examples, and Ways to Minimize Risks. Investopedia. https://www.investopedia.com/terms/a/agencyproblem.asp#:~:text=Error%20Code%3A%20100013)-,What%20Is%20an%20Agency%20Problem%3F,management%20and%20the%20company’s%20stockholders.
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I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,
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