Agency problem and agency cost

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Agency problem and agency cost

  1. 1. By, Nidhish Thampi P11138 PGDM – A
  2. 2.  Agency problem is the likelihood that managers may place personal goals ahead of corporate goals. A characteristic feature of corporate enterprises is the separation between ownership and management. Thus, with the objective of survival, management would aim at satisfying instead of maximizing shareholder’s wealth.
  3. 3.  The agency problem can be prevented by:  Market Forces  Agency Costs Market Forces: It is of two types: Behaviour of security market participants Hostile Takeovers
  4. 4. • Behaviour of security market participants: The participants include institutional investors(mutual funds, insurance etc.) actively participate in management. They use their voting rights to replace more competent management.• Hostile takeovers: It is the acquisition of the firm by another firm that is not supported by management. The constant threat of takeover motivate management to work for maximising owner’s wealth.
  5. 5.  These are the costs borne by shareholders to prevent agency problem as to maximise owners wealth. They have to incur 4 types of costs: Monitoring Bonding Opportunity Structuring
  6. 6.  Monitoring the activities of the management to prevent satisfying and maximising owner’ wealth. It relates to the payment for audit and control procedures to ensure that management is working for maximising owner’s wealth. Bonding protects the owners from the consequences of dishonest acts by management/managers. They firm pays to obtain a fidelity bond from a third party bonding company to compensate for financials loses due to dishonest acts.
  7. 7.  Opportunity costs are those which results from the inability of the firm to respond to new opportunities. Due to organisational structure, hierarchy etc. the management faces difficulties in seizing profitable investment opportunities. Structuring expenditure relates to structuring managerial compensation to maximise owner’s wealth.
  8. 8.  It is of two types:1. Incentive Plans2. Performance Plans Incentive Plans: They tie management compensation to sare price. The most widely used plan is stock options which allows management to acquire shares at special prices. Higher price will result in larger management compensation.
  9. 9.  Performance Plans: These plans compensate management on the basis of its proven performances. Performance shares are given to management for meeting the stated goals Another type, cash bonuses – cash payments are given for achievement of the stated performance goals.
  10. 10. Thank you...!!

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