ManEconCh14 - MANAGERIAL ECONOMICS: THEORY, APPLICATIONS,...

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MANAGERIAL ECONOMICS: THEORY, APPLICATIONS, AND CASES W. Bruce Allen | Keith Weigelt | Neil Doherty | Edwin Mansfield CHAPTER  14 Principal-Agent Issues and  Managerial Compensation
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PRINCIPAL-AGENT ISSUES Principal-Agent Issues: When managers  (agents) make decisions that affect the  wealth of shareholders (principals) Conflict of interest: Personal utility of decision  maker (agent) conflicts with the objectives of the  principal. Issue vanishes when principal and agent have  identical objectives. Manager is the business owner.
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PRINCIPAL-AGENT ISSUES Factors Uncertainty is a factor when the effects of an agent's  decisions are not deterministic. Outcomes may be bad  when decisions are good. Information asymmetry: Agents and principals do not  have the same information sets. Noncooperative game The principals determine compensation rules for the agents. Agents' actions are not directly observable by principals. The consequences of decisions made by agents are not entirely  predictable.
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PRINCIPAL-AGENT ISSUES Managers can anticipate issues associated  with the principal-agent problem and devise  incentive compensation strategies that will  help to minimize the problem. Product liability laws provide incentives for  agents (product manufacturers) to produce safe  products for the principals (consumers).
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THE DIVERGING PATHS OF  OWNERS AND MANAGERS Shareholder goals Maximize value of the firm Alternative management goals Minimizing effort Maximizing job security Avoiding failure Enhancing reputation and employment opportunities Maximizing perquisites Maximizing pay
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THE PRINCIPAL-AGENT  SITUATION Example: Choice of distribution channel by  managers at a life insurance company Existing channel: Low risk, low expected profit Managers may prefer this choice because of low risk. New channel: High risk, high potential profit Stockholders may prefer this choice because of the high  potential profit and because they can reduce risk by holding a  diversified portfolio.
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THE PRINCIPAL-AGENT  SITUATION Example: Charitable giving by a firm Stockholders prefer charitable giving that will provide  strategic benefit to the firm. Managers may have personal agendas that lead to  charitable giving that does not provide strategic benefit  to the firm.
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AND COMPENSATION ON PRINCIPAL- AGENT ISSUES Managerial Behavior and Effort Disutility of effort: A measure of the cost to the  manager of supplying effort Effort imposes personal costs on managers,  who therefore prefer to exert less effort. Effort contributes to increasing the value of the 
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ManEconCh14 - MANAGERIAL ECONOMICS: THEORY, APPLICATIONS,...

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