2. Agency problem is the likelihood that
managers may place personal goals
ahead of corporate goals.
A characteristic feature of corporate
enterprises is the separation between
ownership and management.
Thus, with the objective of survival,
management would aim at satisfying
instead of maximizing shareholder’s
wealth.
3. The agency problem can be prevented by:
Market Forces
Agency Costs
Market Forces:
It is of two types:
Behaviour of security market participants
Hostile Takeovers
4. • Behaviour of security market participants:
The participants include institutional
investors(mutual funds, insurance etc.) actively
participate in management. They use their voting
rights to replace more competent management.
• Hostile takeovers:
It is the acquisition of the firm by another firm that is
not supported by management. The constant threat
of takeover motivate management to work for
maximising owner’s wealth.
5. These are the costs borne by
shareholders to prevent agency problem
as to maximise owners wealth.
They have to incur 4 types of costs:
Monitoring
Bonding
Opportunity
Structuring
6. Monitoring the activities of the management to
prevent satisfying and maximising owner’ wealth.
It relates to the payment for audit and control
procedures to ensure that management is working
for maximising owner’s wealth.
Bonding protects the owners from the
consequences of dishonest acts by
management/managers.
They firm pays to obtain a fidelity bond from a
third party bonding company to compensate for
financials loses due to dishonest acts.
7. Opportunity costs are those which
results from the inability of the firm to
respond to new opportunities.
Due to organisational structure, hierarchy
etc. the management faces difficulties in
seizing profitable investment
opportunities.
Structuring expenditure relates to
structuring managerial compensation to
maximise owner’s wealth.
8. It is of two types:
1. Incentive Plans
2. Performance Plans
Incentive Plans:
They tie management compensation to sare
price.
The most widely used plan is stock options
which allows management to acquire shares
at special prices. Higher price will result in
larger management compensation.
9. Performance Plans:
These plans compensate management on
the basis of its proven performances.
Performance shares are given to
management for meeting the stated goals
Another type, cash bonuses – cash
payments are given for achievement of
the stated performance goals.
