The agency problem agency problem the likelihood that

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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 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. incentive plans Management compensation plans that tend to tie management compensation to share price; most popular incent...
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This document was uploaded on 01/19/2014.

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