2. Agency conflicts between managers and shareholders

Remember, an agency relationship can degenerate into an agency conflict when an agent acts in a manner that is not in the best interest of his or her principal. In large corporations, these conflicts most frequently involve the enrichment of the firms executives or managers (in the form of money and perquisites or power and prestige) at the expense of the companys shareholders. This usurping and reallocation of shareholder wealth is most likely to occur when shareholders do not have sufficient information about the decisions and actions being made by the firms management.

Consider the following scenario and determine whether an agency conflict exists:

William and Abigail equally own and manage A New Beginning (ANB), a store that sells preowned clothing and furniture. William is responsible for ANBs back-office activities, and Abigail staffs the store and makes deliveries to customers. Both have equal decision-making authority and, under the terms of their partnership agreement, both are prohibited from making personal purchases using company funds without prior approval of the other partner. William, without Abigails knowledge, used the companys bank account recently to purchase a new sports car. William has acknowledged that the car will not be used to support the business.

Is this a potential agency conflict between William and Abigail?

No; William and Abigail are both authorized to spend ANBs money, so no conflict of interest can occur.

No; William and Abigail co-own and co-manage ANB and have a partnership agreement that makes them equal, so an agency conflict cannot exist.

Yes; William is misappropriating some of Abigails wealth by unilaterally purchasing a nonbusiness asset using ANBs funds.

Yes; it should have been Abigail who purchased the car.

Consider the following scenario and determine whether an agency conflict exists:

Five years ago, Caesar created a plant-care business that grew, stocked, and maintained fresh plants in office buildings throughout Raleigh. Over time, The Green Zone Inc. (TGZ) has grown from a proprietorship into a corporation, now reaching far beyond Raleigh. To finance and support this growth, TGZ issued shares that were sold to TGZ employees, Caesars family members, and selected outsiders. Caesar is TGZs chairman of the board of directors and CEO, but he is no longer the largest shareholder.

At the latest annual meeting, two mutually exclusive proposals were placed on the ballot for discussion and vote. The first was put forth by Caesar and TGZs management team, and the second was proposed by a small group of other shareholders. Both groups are adamantly opposed to the other groups proposal, even though both proposals would likely have the same effect on TGZs value and riskiness.

Does an agency conflict exist between TGZs management and the small group of opposing shareholders?

No; although an agency relationship exists between TGZs managementincluding Caesar as TGZs chairman and CEO and the firms shareholdersthere is no agency conflict, because no expropriation or wasting of the shareholders wealth has occurred.

No; Caesar was the original owner of TGZ, so he would always be sensitive to the concerns of the firms current owners (shareholders) and would not engage in an agency conflict.

Yes; any conflict or disagreement between the firms managers and its shareholders constitutes an agency conflict.

Yes; an agency relationship exists, and an agency relationship always gives rise to agency conflicts, regardless of the actual behavior of the participants.

Which of the following actions will help ease agency conflicts and better align managers objectives with the firms shareholder wealth?

Pay the manager a large base salary with a huge stock option package that matures on a single date.

Pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth.

Great Fortunes Baking Companys stockholders are mostly individual investors, and there is relatively little institutional ownership. If several pension and mutual funds were to take large positions in Great Fortunes Baking Companys stock, direct shareholder intervention would be more or less likely to motivate the firms management.

In the late 1980s and early 1990s, Congress passed legislation making it more difficult for outside investors to stage hostile takeovers. This legislation likely reduced or increased conflicts between managers and stockholders.