Agent Problem
Essay title: Agent Problem
The relationship between stockholders and management is called an agent relationship. Such a relationship exists the whenever someone (principle) hires another (agent) represent his or her interest. In the agent relationship, management and stockholder might have different interests; therefore, a possibility of conflict of interest might exist. Such a conflict is called agency problem.
Hires
Self-
interest
Self-
interest
Performs
For Example, a new investment plan is considered which expect to favourably impact stock price, however, It also have a relatively risk. Because the stock price will rise, the stockholder will wish to take the investment, but management might not because the investment may fail that the management jobs will be lost. But if management does not take the investment, then the stockholders lose a chance to make money. This example is called agency cost. However, if left to themselves, managers would focus on the business power or wealth. This goal could case to an overemphasis on business size or growth. Therefore, management keep organizational survival to security.
As the graph shown, there is information asymmetric between stockholder and management. Management to a transaction has more or better information than the stockholders. This creates an imbalance in power in transactions. Asymmetric information can be financial information and business information. Also a self-interested manager could divert company funds for consumption of value-reducing private benefits. Increasing the debt level (and reducing outside equity) aligned the manager with the investors by increasing the manager’s personal equity stake in the firm, hence reducing his incentives to take private benefits and considered self-interested managers’ incentives to waste free cash flow on empire-building, value-reducing, projects. Increasing debt commits managers to paying out to debt holders, hence reducing the free cash flow problem. There are always empire building appear in the management as the manager allowed to hire staff based on the relationship rather than employ based on ability. Therefore, the manager can build up his or her kingdom in the company. Moreover, managers tend to evaluate projects based on the short-term profits that typically determine their own remuneration (Sternberg 2004). The issue is that managers may make decisions, not for long-term financial growth, but to increase their own wealth. While it seems that this might benefit shareholders, these short-term decisions can often have negative affects in the future and are not necessarily good for shareholders. In addition, since managers have more information about company performance than do shareholders, there is a fear that management will abuse their power to make themselves wealthier at the cost of long-term financial stability. Different view for evaluation of risk, Different people is willing to take different level of risk, manager might take too much risk as the shareholder doesn’t want to or manager take too few risk that does not appreciate the shareholders.
In additional, the single owner-manager (which called “insider” blew) 100% owns and runs the firm, and firm value is influenced by the quantity of perks consumed (perk). The value of the firm will be V* and the perks consumed, F*. The maximum a potential buyer (outsider) of equity in the business will be willing to pay, provided the perk consumption is guaranteed to remain the same, will be V*. after a fraction of the firm has been sold be a, then the outsider now owns (1-a), (0