Agency conflicts

Topics: Executive compensation, Stock, Board of directors Pages: 29 (9479 words) Published: May 25, 2014
Table of content
Preface………………………………………………………………….1 Chapter 1. Prerequisites of the agency problem and different approaches to solving it 1.1 How we detect an agency problem……………………………………..3 1.2 Remedies of agency problem…………………………………………….5 1.3 Different approach for different types of companies……………….10 Chapter 2. Practical examples of agency problem's solution

2.1 Good intentions usually backfire……………………………………….13 2.2 Positive examples and new ideas………………………………….........17 2.3 Foregoing research: “pay-for-performance” for employees and compensation consultants………………………………………………………………………19 Chapter 3. Findings……………………………………………………………21 Conclusion………………………………………………………………………24 List of used literature…………………………………………………………..26 Preface

On the modern market there are different types of entities, and even though small and some of middle – sized companies are founded as sole entrepreneurs and LLC, all big or multinational companies, which have the largest market shares and values, are chartered as joint-stock companies, as far as joint capital is one of the most easily obtained, managed and with a moderate cost. The genius of public corporations stems from their capacity to allow efficient sharing or spreading of risk among many investors, who appoint a professional manager run the company on the behalf of shareholders.

However, the public corporation has a key weakness - namely, the conflicts of interest between managers and shareholders. The separation of the company’s ownership and control, which is especially prevalent where corporate ownership is highly diffused, gives rise to possible conflicts between shareholders and managers. In theory, shareholders elect the board of directors of the company, which in turn hires managers to run the company for the interests of shareholders. Managers are supposed to be agents working for their principals, that is, shareholders, who are the real owners of the company. In a public company with diffused ownership, the board of directors is entrusted with the vital tasks of monitoring the management and safeguarding the interests of shareholders.

Unfortunately, with diffused ownership, few shareholders have strong enough incentive to incur the costs of monitoring management themselves when the benefits from such monitoring accrue to all shareholders alike. The benefits are shared, but not the costs. When company ownership is highly diffused, this “free-rider” problem discourages shareholder activism. As a result, the interests of managers and shareholders are often allowed to diverge. With an ineffective and unmotivated board of directors, shareholders are basically left without effective recourse to control managerial self-dealings. Recognition of this key weakness of the public corporation can be traced at least as far back as to Adam Smith’s Wealth of Nations (1776), which stated: The directors of such joint-stocks companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners of a private copartnery frequently watch over their own. . . . Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

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, including the works of Locke and Hobbes. Some noteworthy scholars involved in agency theory's formative period in the 1970s included Armen Alchian, Harold Demsetz, S.A. Ross and the famous paper “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” of Michael Jensen and William Meckling.

In an ideal situation the manager (or entrepreneur) and the investors sign a contract that specifies how the manager will use the funds and...
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