1. Agency conflicts and costs The nature and effects of agency conflicts Agency conflicts are a special example of a conflict of interest; specifically, they are created by the relationship between and result from inconsistencies or disputes between the interests and motivations of the different parties. The magnitude of these conflicts may be made larger or smaller by the environment in which they occur and the availability of techniques or events to prevent, reduce, or rectify them. For example, in businesses managed by professional managers, managers frequently have less financial and emotional commitment to the business than the firm's owners (the firm's common shareholders). The of ownership and management and the of decision making by the owners to the professional managers create an environment in which these conflicts can take root. Left unaddressed, these conflicts can produce significant real and opportunity costs that the firm's shareholders and other stakeholders must bear. Examples of management behaviors that are not in the best interests of the firm's shareholders include shirking, an excessive consumption of perquisites, an excessive concern with job security, reduced or excessive risk taking, and/or undertaking activities that are principally intended to expand or enhance a manager's ego, prestige, or power. To prevent, reduce, or correct these conflicts between their managers and themselves, shareholders often have to incur additional real costs called costs. In general, there are four categories of real or opportunity costs incurred by shareholders designed to prevent, mitigate, or correct management- shareholder agency conflicts. They are: 1. Expenditures to minimize management's desire to act contrary to the best interests of shareholders 2. Expenditures to monitor management's activities 3. Expenditures to provide a bond against management dishonesty 4. The opportunity cost of lost profits Consider the following situation and identify both the category of the expenditure and the best device that might be used to prevent, reduce, or correct the agency conflict: A firm's plant manager is afraid that her facility may be closed and her job outsourced to a lower-cost country. To make herself look good, she sets lower-than-appropriate performance goals. Expenditure category: O 1 O 3 O4 O 2 Most appropriate form of control device: Hire an external consultant to address the psychological concerns of the plant managers. Develop a management evaluation and compensation program that puts the burden on the management team to reduce shirking or excessive concern about job security. Develop a code of ethics that prohibits shirking