The principal agent framework

Question 1

The principal-agent problem (agency problem)

Answer 1

arises from the separation of ownership from control

Question 2

Agency costs

Answer 2

costs arising from the separation of ownership and control.

Question 3

do agency costs affect company performance?

Answer 3

• major reason for disallowing M&A
• undeserved executive compensation
• if funds mismanaged by managers due to self-interest, investors are reluctant to provide funds.

Question 4

Agency theory perspective

Answer 4

dispersion of ownership and separation of ownership and control (Berle and Means, 1932)

Question 5

Agency theory finance theory objective

Answer 5

assumed to be the maximisation of shareholder wealth.

Question 6

Agency theory: predominant view in UK and US

Answer 6

result of cultural and historical factors

Question 7

different countries

Answer 7

different forms of ownership: different objectives and perspectives.

Question 8

Monitoring costs

Answer 8

• incurred by principals
• auditing
• formal control systems
• budget restrictions
• establishment of incentive compensation systems

Question 9

Bonding Costs

Answer 9

• incurred by agent
• contractual guarantees to have accounts audited
• contractual limitation on managerial decision making power
• guarantee to outside equity holders that limit activities

Question 10

Residual loss

Answer 10

costs incurred from divergent principal and agent interests despite the use of monitoring and bonding.

Question 11

agency theory solutions

Answer 11

• voice
• contracts
• markets
• exit

Question 12

executive power and pay

Answer 12

• too much power can be given to senior executives
• power can be abused, damages company
• execs can decide their own incentives

Question 13

Myopic market model

Answer 13

• firms purpose remains maximisation of shareholder wealth
• short termism

Question 14

shareholder goals

Answer 14

long term

Question 15

manager goals

Answer 15

short term

Question 16

myopic market model solutions

Answer 16

• board diversity
• locking in shareholder (reduce exit)
• restricting voting rights of new shareholders
• empowerment of stakeholders (increase voice)
  all impose costs however

Question 17

william’s managerial utility maximising model

Answer 17

• managers have expense preferences
• managers want incentives

Question 18

the behavioural approach

Answer 18

• organisations do not have objectives, only people have objectives

Question 19

the firm does not exist

Answer 19

it is a set of shifting coalitions of individuals

Question 20

the stakeholder model

Answer 20

• argues objective function should be about more than maximising shareholder wealth.
• a more equitable and socially efficient model
• contradicts all other views

Question 21

stakeholder model perspective

Answer 21

takes into account a wider group of constituents (stakeholders)

Question 22

stakeholder model rationale

Answer 22

companies are so large and have such an impact on society that they should be accountable not only shareholders but wider sections of society.