The principal agent framework Flashcards
The principal-agent problem (agency problem)
arises from the separation of ownership from control
Agency costs
costs arising from the separation of ownership and control.
do agency costs affect company performance?
- major reason for disallowing M&A
- undeserved executive compensation
- if funds mismanaged by managers due to self-interest, investors are reluctant to provide funds.
Agency theory perspective
dispersion of ownership and separation of ownership and control (Berle and Means, 1932)
Agency theory finance theory objective
assumed to be the maximisation of shareholder wealth.
Agency theory: predominant view in UK and US
result of cultural and historical factors
different countries
different forms of ownership: different objectives and perspectives.
Monitoring costs
- incurred by principals
- auditing
- formal control systems
- budget restrictions
- establishment of incentive compensation systems
Bonding Costs
- incurred by agent
- contractual guarantees to have accounts audited
- contractual limitation on managerial decision making power
- guarantee to outside equity holders that limit activities
Residual loss
costs incurred from divergent principal and agent interests despite the use of monitoring and bonding.
agency theory solutions
- voice
- contracts
- markets
- exit
executive power and pay
- too much power can be given to senior executives
- power can be abused, damages company
- execs can decide their own incentives
Myopic market model
- firms purpose remains maximisation of shareholder wealth
- short termism
shareholder goals
long term
manager goals
short term
myopic market model solutions
- board diversity
- locking in shareholder (reduce exit)
- restricting voting rights of new shareholders
- empowerment of stakeholders (increase voice)
all impose costs however
william’s managerial utility maximising model
- managers have expense preferences
- managers want incentives
the behavioural approach
- organisations do not have objectives, only people have objectives
the firm does not exist
it is a set of shifting coalitions of individuals
the stakeholder model
- argues objective function should be about more than maximising shareholder wealth.
- a more equitable and socially efficient model
- contradicts all other views
stakeholder model perspective
takes into account a wider group of constituents (stakeholders)
stakeholder model rationale
companies are so large and have such an impact on society that they should be accountable not only shareholders but wider sections of society.
