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:

Last week, an investigative reporter for a major metropolitan newspaper discovered that the doctors conducting clinical trials of a new cancer treatment drug are also the principal shareholders in Cancer Solutions Inc. (CSI). CSI is the company developing and attempting to market the drug. Upon being interviewed by federal authorities, the doctors acknowledged their conflict of interest but reported that they were sold the shares at a 75% discount by CSIs chief financial officer. The CFO was concerned that CSI might not be able to meet its annual performance objectives and in turn pay his anticipated multimillion-dollar bonus.

A.Does an agency conflict exist between CSIs CFO and the companys shareholders?

A. Yes; the shares should not have been sold at a 75% discount, which is price discrimination.

B. No; in general, shareholders are satisfied with company officers engaging in any type of legal or illegal activity to ensure the chances of them receiving greater dividend payments.

C. No; professionals, such as doctors and professional money managers, would not participate in unethical activities.

D. Yes; CSIs CFO engaged in unethical conduct to manipulate the firms short-term earnings and improve the likelihood of receiving his annual bonus.

B.Consulting firms and human resource departments have spent innumerable hours attempting to develop executive compensation programs that will align the goals of a firms managers with those of the firms shareholders. Which of the following compensation packages is most likely to accomplish this task?

A.An annual salary of $500,000 and a stock option bonus package that provides 100,000 shares after one year

B.An annual salary of $250,000 and a stock option bonus package that provides 250,000 shares after five years

C. An annual salary of $500,000 and a stock option bonus package for a total of 250,000 shares, with 50,000 shares vesting at the end of each of the next five years

D. An annual salary of $800,000

C.In addition to well-designed executive compensation packages, two other motivational forces can align the interests of managers with those of their shareholders. Which of the following actions could be used to reduce the potential for these agency conflicts and ensure that the firms managers will pursue the long-term wealth interests of their shareholders?

A.Let the manager know that he or she will be fired if the companys stock does not reach a certain target by the end of the year.

B. Let the manager know that a takeover is possible if he or she doesnt perform well.

Thanks for the Help!