1. Agency conflicts and costs

The nature and effects of agency conflicts

1. 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.

2. For example, in businesses managed by professional managers, managers frequently have less financial and emotional commitment to the business than the firms owners (the firms 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.

3. Left unaddressed, these conflicts can produce significant real and opportunity costs that the firms shareholders and other stakeholders must bear. Examples of management behaviors that are not in the best interests of the firms 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 managers 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.

4. In general, there are four categories of real or opportunity costs incurred by shareholders designed to prevent, mitigate, or correct managementshareholder agency conflicts. They are:

	1. Expenditures to minimize managements desire to act contrary to the best interests of shareholders
	2. Expenditures to monitor managements 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 firms president and management team are all buddies and run the organization to make the president look good in the Wall Street Journal. Which category is correct?

Expenditure category:

1

3

4

2

5. Most appropriate form of control device:

-Enforce a corporate governance program that provides for an independent board of directors that will vigorously oversee and take action against the president and the management team if warranted.

-Identify a competitor to take over the company.

-Increase the pay and bonus of the president and the management team.