7. 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:

Daniel and Ashley equally own and manage A New Beginning (ANB), a store that sells preowned clothing and furniture. Daniel is responsible for ANBs back-office activities, and Ashley 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. Daniel, without Ashleys knowledge, used the companys bank account recently to purchase a new sports car. Daniel has acknowledged that the car will not be used to support the business.

Is this a potential agency conflict between Daniel and Ashley?

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

No; Since Daniel acknowledged that the car would not be used to support the business, no agency conflict can arise.

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

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

For the past 40 years, companies have attempted to attract, retain, and encourage managers by developing attractive compensation packages. These compensation packages have also been intended to reduce potential agency conflicts between these managers and the firms shareholders.

In the best interest of shareholders, compensation packages should be structured in a way such that managers have an incentive to maximize the value of the companys common stock price.

True or False: A small number of institutional investors are often able and motivated to bring direct shareholder pressure on a firms management in an effort to reduce potential agency conflicts.

False

True