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									       The Principal-Agent Problem

• Ownership & control: “the large
  corporation is owned by so many
  shareholders that no single shareholder
  owns a significant proportion of the outside
  stock. Therefore no single shareholder has
  the power to really control the actions of
  the officers of the corporation”.

• “Negligence and profusion … must always
  prevail in such a company.”
       The Principal-Agent Problem

• The bulk of the dividends go to outside
  shareholders.
• All the major decisions are taken by the
  corporate officers.
• The outside shareholders are unable to
  control the corporate officers.
• The interests of the shareholders and the
  corporate officers diverge significantly.
       The Principal-Agent Problem

• Shareholders: PROFIT

• Corporate Officers: POWER, PRESTIGE,
  PERSONAL WEALTH

• Senior managers may be in a position to
  enrich themselves at the expense of the
  shareholders.
Sales revenue maximising with a profit constraint
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                                             TC



                                              TR




 P
  O                                                   Q
                          Q2   Q3 Q1
                                       Total profit
   ALTERNATIVE MAXIMISING THEORIES

• Sales revenue maximisation
  – equilibrium output and price
  – comparison with profit-maximising output and
    price
  – effect of a minimum profit constraint
  – implications for advertising
  – comparisons with short-run profit maximising
  – implications for the consumer
  – assessment of the theory
  ALTERNATIVE MAXIMISING THEORIES

• Growth as a motive for firms
  – growth maximisation
  – means of achieving growth
• Growth by internal expansion
  – sources of funds
  – the takeover constraint
• Growth by merger and take over
  – types of merger
  – merger activity
               Agency Theory

• Agency theory in its simplest form
  discusses the relationship between two (or
  more) people, a principal and an agent who
  makes decisions on behalf of the principal.

• Owners of firms and their managers.

• Patient-doctor.

• Managers and their subordinates.
               Agency Theory

• All agency relationships involve moral
  hazard.

• “the principal and the agent may have
  different objectives and the principal
  cannot easily determine whether the
  agent’s reports and actions are being taken
  in pursuit of the principal’s goals or self-
  interested behaviour.”
               Agency Theory

• Informational Asymmetry

• Monitoring

• The Free Rider Problem
     External Constraints on Managers

• The Product Market

• The Market for Corporate Control

• The Market for Managerial Labour
       Internal Control Mechanisms

• Performance Related Pay

  – concentrates the risk of agents
  – promotes short term profit
  – share options schemes are asymmetric

  – compensation committees


  – size does matter
      Additional Control Mechanisms

• The Board of Directors

• Multiple Principals - the Role of the Banks

• Managerial Bonding: the Role of Debt

								
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