User talk:Emmanuel Ameh: Difference between revisions
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imported>Emmanuel Ameh (Agency Problem.) |
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Agency Problem | |||
An agency problem normally arises when there are conflicts of interest that arise between the owners of a publicly traded company i.e. stockholders, bondholders, shareholders and those appointed to manage the interest of the owners called agents. These shareholders are generally referred to as the principal and the managers are known as the agents and are paid to serve on behalf of the principal’s interest. | |||
Agents are therefore given the necessary powers to make decisions that are presumed to be in the best interest of the principal. The result of the use of powers and decisions made are often not in the best interest of principal or shareholders but in that of the agent. This is thus considered to be the ‘Agency Problem.’ | |||
Agency problem is therefore not only peculiar to the stock market but can be traced in any relationship where the burden of trust is cast on one party (trustee or shareholder) who is expected to act or holder something in trust for the beneficiary. | |||
In principle, the owners of the company i.e. shareholders are considered to be in control of the company but it is actually the appointed directors i.e. agents that manage the gains and losses on the shares. The agents are also considered to be the ones in charge because they manage large expanse of shares and they are cut out for such expertise. This issue of agency problem may therefore not arise if the agent who is entrusted with resources by the principal truly manages the resources in good faith to the benefit of the principal. | |||
For directors or agents to act in the best interest of the principal they have to get compensated for their services. This compensation is regarded as the ‘Agency Cost’. Agency cost is paid out in the form of compensation and incentive that are directed at controlling the excesses of agents. Also incentives are paid out to agent in order to encourage agents to grow the shareholder’s wealth. Where these soft measures fail to align the goals and objectives of the agents with that of the principal tougher measures are applicable. These measures include but are not limited to: | |||
Dismissal of Agent: Where the agent fails to act in the best interest of the principal in building value-add for the principal’s investment, the agent could be sacked or dismissed. | |||
Corporate Regulations: There policies and regulations that generally enacted as a means of keeping the activities of agents in check. The primary goal of such legislation is to protect the shareholders’ wealth from wanton mismanagement by the agents. | |||
Information flow: Information flow is crucial to monitoring the activities of directors that act in the interest of their beneficiaries. Through annual, quarterly or timely released reports to the corporation investors learn more about the profitability or losses of the stocks and shares performance. This in turn enables the investors to make decisions about the directors’ ability to generate value or make losses on investors’ interest. | |||
Reward to shareholders for improving wealth: | |||
Agents are sometimes with shares option for improving wealth and creating value-add on shareholders interest. Shares option enables the agents/directors to buy company shares at an agreed price today on a future date. If the price of the shares rises over and above the purchase price before that future date the agent can cash-in by selling the shares for higher price. This creates a win-win situation for both the principal and the directors besides it discourages the directors from acting in ways that would not benefit the shareholders. | |||
Threat of Take-Over/Sale of Shares: Stockholders or principals that control large amount of company shares obviously have strong standing in the company’s decision making process. Therefore, agents who represent such stockholders and fail to act in their best interest are likewise subject to penalty through the sellout of shares within their control. When major stockholders in a company sell their shares it can force the value of stock to drop and devalue the company’s worth and worse case scenario cause the management/directors to lose their jobs. | |||
http://cbdd.wsu.edu/kewlcontent/cdoutput/tr505r/page6.htm | |||
Latest revision as of 21:04, 1 May 2008
Agency Problem
An agency problem normally arises when there are conflicts of interest that arise between the owners of a publicly traded company i.e. stockholders, bondholders, shareholders and those appointed to manage the interest of the owners called agents. These shareholders are generally referred to as the principal and the managers are known as the agents and are paid to serve on behalf of the principal’s interest.
Agents are therefore given the necessary powers to make decisions that are presumed to be in the best interest of the principal. The result of the use of powers and decisions made are often not in the best interest of principal or shareholders but in that of the agent. This is thus considered to be the ‘Agency Problem.’
Agency problem is therefore not only peculiar to the stock market but can be traced in any relationship where the burden of trust is cast on one party (trustee or shareholder) who is expected to act or holder something in trust for the beneficiary. In principle, the owners of the company i.e. shareholders are considered to be in control of the company but it is actually the appointed directors i.e. agents that manage the gains and losses on the shares. The agents are also considered to be the ones in charge because they manage large expanse of shares and they are cut out for such expertise. This issue of agency problem may therefore not arise if the agent who is entrusted with resources by the principal truly manages the resources in good faith to the benefit of the principal. For directors or agents to act in the best interest of the principal they have to get compensated for their services. This compensation is regarded as the ‘Agency Cost’. Agency cost is paid out in the form of compensation and incentive that are directed at controlling the excesses of agents. Also incentives are paid out to agent in order to encourage agents to grow the shareholder’s wealth. Where these soft measures fail to align the goals and objectives of the agents with that of the principal tougher measures are applicable. These measures include but are not limited to:
Dismissal of Agent: Where the agent fails to act in the best interest of the principal in building value-add for the principal’s investment, the agent could be sacked or dismissed.
Corporate Regulations: There policies and regulations that generally enacted as a means of keeping the activities of agents in check. The primary goal of such legislation is to protect the shareholders’ wealth from wanton mismanagement by the agents.
Information flow: Information flow is crucial to monitoring the activities of directors that act in the interest of their beneficiaries. Through annual, quarterly or timely released reports to the corporation investors learn more about the profitability or losses of the stocks and shares performance. This in turn enables the investors to make decisions about the directors’ ability to generate value or make losses on investors’ interest. Reward to shareholders for improving wealth: Agents are sometimes with shares option for improving wealth and creating value-add on shareholders interest. Shares option enables the agents/directors to buy company shares at an agreed price today on a future date. If the price of the shares rises over and above the purchase price before that future date the agent can cash-in by selling the shares for higher price. This creates a win-win situation for both the principal and the directors besides it discourages the directors from acting in ways that would not benefit the shareholders. Threat of Take-Over/Sale of Shares: Stockholders or principals that control large amount of company shares obviously have strong standing in the company’s decision making process. Therefore, agents who represent such stockholders and fail to act in their best interest are likewise subject to penalty through the sellout of shares within their control. When major stockholders in a company sell their shares it can force the value of stock to drop and devalue the company’s worth and worse case scenario cause the management/directors to lose their jobs.