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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Michael owns Michaels Tantalizing Tees, a T-shirt shop in a small college town in New Hampshire. With a staff of three part-time employees, Michael operates the business in accordance with his personal goals, dreams, and capabilities.

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Does Michael have an agency conflict to deal with?

a) No; as both the owner and operator of Michaels Tantalizing Tees, Michael has not created the necessary agency relationship through which an agency conflict can exist.

b) Yes; as both the owner and operator of Michaels Tantalizing Tees, Michael has created the necessary agency relationship through which an agency conflict can exist.

c) No; by having part-time, as opposed to full-time, employees, Michael is prevented from experiencing an agency conflict.

d) Yes; there is always an inherent conflict of interest between owners and operators (managers).

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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 $250,000 and a stock option bonus package that provides 250,000 shares after five years

b) 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

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

d) An annual salary of $800,000

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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.

a) False

b) True