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Unformatted text preview: rned with
their personal wealth, job security, and fringe benefits. Such concerns may make
managers reluctant or unwilling to take more than moderate risk if they perceive
that taking too much risk might jeopardize their jobs or reduce their personal
wealth. The result is a less-than-maximum return and a potential loss of wealth
for the owners. The Agency Problem
The likelihood that managers
may place personal goals ahead
of corporate goals. From this conflict of owner and personal goals arises what has been called the
agency problem, the likelihood that managers may place personal goals ahead of
corporate goals.6 Two factors—market forces and agency costs—serve to prevent
or minimize agency problems.
Market Forces One market force is major shareholders, particularly large
institutional investors such as mutual funds, life insurance companies, and
pension funds. These holders of large blocks of a firm’s stock exert pressure on
management to perform. When necessary, they exercise their voting rights as
stockholders to replace underperforming management. 5. For an excellent discussion of this and related issues by a number of finance academics and practitioners who have
given a lot of thought to financial ethics, see James S. Ang, “On Financial Ethics,” Financial Management (Autumn
1993), pp. 32–59.
6. The agency problem and related issues were first addressed by Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3
(October 1976), pp. 305–306. For an excellent discussion of Jensen and Meckling and subsequent research on the
agency problem, see William L. Megginson, Corporate Finance Theory (Boston, MA: Addison Wesley, 1997),
Chapter 2. 20 PART 1 Introduction to Managerial Finance agency costs
The costs borne by stockholders
to minimize agency problems.
plans that tend to tie management compensation to share
price; most popular incent...
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- Fall '13