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:

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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.

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Is this a potential agency conflict between Daniel and Ashley?

a) 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.

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

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

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

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

a) 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.

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

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 a takeover is possible if he or she doesnt perform well.

b) 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.