Questions on Corporate Finance

Only available on StudyMode
  • Download(s) : 73
  • Published : November 9, 2012
Open Document
Text Preview
Wk1 DQs
What is meant by an "agency cost" or "agency problem"? Do these interfere with shareholder wealth maximization? Why? What mechanisms minimize these costs/problems? Are executive compensation contracts effective in mitigating these costs/problems? Our textbook defines an agency problem as a “conflict between the goals of a firm’s owners and its managers” (Megginson & Smart, 2009). It then defines agency costs as dollar costs that arise because of this conflict. In the corporate structure, stockholders are the owners of the firm, and they elect a board of directors to oversee the firm and help protect their investment. The board then hires the right corporate managers to run the firm with the goal of maximizing the wealth of the shareholders. In a vacuum, this is a perfect framework by which to run a corporation; however, the reality is that a corporation’s managers are influenced and driven both by the company’s goals and by their own personal goals. Our textbook lists a few of those goals on page 25 as personal wealth, job security, lifestyle, prestige, and ‘perks’ (Megginson & Smart, 2009). These agency problems can directly interfere with the corporation’s goal of shareholder wealth maximization because of the costs that these problems create. For example, an executive might become so focused on his personal goals that he “takes his eye off the ball” of the company’s goals. In addition, the board may have to institute costly auditing or bonding measures to ensure the effectiveness of its managers, or protect the company from executive wrongdoing. Our text lays out three broad ways that shareholders can try to mitigate these types of agency problems; they are: relying on market forces, structured executive compensation packages, and the auditing/bonding measures discussed above (Megginson & Smart, 2009). The “market forces” category is loosely defined as the pressure put on a business by the rest of the market and its competitors. This can...
tracking img