The Sources and Ramification of Agency Problems Within the Firm

Subject: Business
Type: Exploratory Essay
Pages: 6
Word count: 1669
Topics: Logistics, Accounting, Finance, Management

In a corporate setting, the managers who are in charge of the firm will always act in the interest of the shareholders. The managers will always strive to make sure that they have attained the maximum shareholders’ interest in the firm. Moreover, the managers will make sure their actions will ensure that they enhance the value of the stock. The level of management that is offered by the management depends on the size of the corporation (Mitnick, 2015).  If the corporation is large, then the efficiency level in the management of the firm depends totally on the management of the managers and not the shareholders. On the other hand, if the size of the shareholders is small then the management of the firm will be done by both the managers and the shareholders. At the point where the management of the firm is done by the managers, we ask whether the managers will act in the best interest of the shareholders. Besides that, will we ask whether the managers will go on to pursue their interest at the expense of the interest of the shareholders?

Agency relationship always occurs in a corporation when the shareholders who are the principal hire the managers who are the agents to represent the shareholders in the achievement of their goals (Bosse and Phillips, 2016). It this kind of a relationship, there will be a high probability of eruption of the conflict of interest between the two parties. This is the kind conflict we refer to as the agency problem. When it is a conflict is between the firm`s managers and the capital provider then it will be an agency problem in a corporate setting. In this paper, we are going to identify the some of the sources that result to agency problem in a firm. Also, we are going to look at the ramification that agency problem might have to the firm (Mitnick, 2015).  What the sources of agency problems depend on the agency relationship is attained in the firms. Among the sources of the agency, problem includes how the manager is compensated by the shareholder, what level of control or attainment of the firm’s goals and objectives.

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The first source of agency problem is managerial compensation. When the managers perform their duties and responsibilities in a manner that will increase the shareholder value, then the shareholders will reward them appropriately (Bosse and Phillips, 2016). If the shareholders do not reward the managers, the managers will get different ways of enhancing their interest in the firm. For instance, the managers in a firm will always have two economic incentives in making sure they enhance the shareholder`s value. 

The first reason is that for the managers to be compensated the shareholders have to look at the financial performance and the share value of their firm. If the firm is doing well, then the shareholders will give the managers the opportunity to buy the stock at a negotiable price. This will act as a form of compensation and reward for the managers for their outstanding performance.  Therefore, the more the value of the firm the more the rewards to the managers. For instance, in the year 2001, the company of Intel gave an issuance of more than eighty thousand new stock options (Bosse and Phillips, 2016). The act of Intel giving their employees a significant amount of their stock gave a better alignment of the employees and the shareholders` interest. This is a type of strategy that most businesses whether big or small have adopted in the operation of their businesses.

The other way that shareholders solve the issue of agency problem and to avoid the conflict of interest within the firm is to enhance their job prospects (Mitnick, 2015). The firm will keep the interests of the managers aligned with their interest in promoting them for their better performance in the firm that tends to increase the shareholders` interest. The managers who have been successful in the accomplishing the shareholders` interest and goals have more demand in the market thus attracting more rewards within firms. When the firms do not reward their managers for the work well done, then the managers will pursue their interest. In the long-run, this will represent a source of agency problem in the firm.

Furthermore, the second source of agency problem within a firm is the degree of control within a firm. There will always be a conflict of interest between the shareholders, the bond of directors and the managers (Mitnick, 2015). Each of the above stakeholders will want to control the firm to a given level. The control of the firm rest on the power of the shareholders. They are the individuals in a firm that elect the board of directors, and it is the power of the board of directors to employ the managers. All of the above players have a crucial part in the control and management of the firm. Conflict of interest will arise when each of the players will different interest in the management and control of the firm, and this will result in agency problem in the firm. A good example of this situation is the Apple Company. Steve Jobs who was the founder of the company was laid-off from the company due to the existence of a conflict of interest within the firm. The board of directors in the company had more power in the control of the firm and saw that the effort of their founder was not essential in the running of the firm. The different power of control in the company resulted in a conflict of interest (Bosse and Phillips, 2016). The consequence of such source of agency problem in the firm is that some of the players in the firm will be laid off. The different control power will be misused within the firm.

In addition, the third source of agency problem within a firm is the management goals and objectives of the firm. The managers and the shareholder might have different forms of goals and objectives that they have planned for the company (Mitnick, 2015). The goals that the managers might not be supported by the shareholders and the inverse is also true. Such a situation will result in a conflict of interest within the two players thus resulting to agency problem within the firm. The firm might identify a lucrative business investment to undertake, and it happens that the same investment is so risky in that it will impact the firm. Conflict of interest will erupt within the firm between the managers and the shareholders. The shareholders will spire head the undertaking of the business investment as it will enhance their value within the firm thus rise in stock value. On the other hand, the managers will not support the business investment due to the risk associated with the investment (Bosse and Phillips, 2016). They will not support the project as things might not turn out as expected and it will affect the company. Many of the employees will lose their job as a result of the implication of the undertaken project thus managers not in support of the project.  If the managers do not undertake the investment, then the shareholders will lose their stock value chance. Such a situation is a source of agency problem within the firm.

Relationship of agency problems between the firm managers and capital provider 

The firm managers are concerned with their interests. They will give more focus to their wealth, fringe benefits and more salaries. On the other hand, the capital providers are the plays in a firm that provide capital to be used to run the various activities of the firm (Mitnick, 2015). The credit providers will want to make sure that their funds are properly utilized and yield the highest returns within the shortest time possible. The managers and the credit provider have a different interest in the place and this result in a conflict of interest between them. If the manager pursues their interest, then the consequences of this are the reduction of the credit providers` wealth and returns. The manager is always in a dilemma of either comprising his interest for the same of the credit provider`s interest. Because the managers have a better understanding of the company, then they will manipulate the data and figure to their advantage.  Thus the managers not working to the attainment of the credit providers’ interest because of less compensation and rewards are given to them by the credit providers.

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Furthermore, the agency problem within a corporate firm might be rampant between the managers and the credit providers when the managers seek more of glory and satisfaction than concentrating on higher returns. Managers might have the habit of giving their corporate earning that meant for the credit provider to enhance their glory and satisfaction among colleagues (Mitnick, 2015). The managers might not support the interests and the goals of the credit providers by them practicing the act of poison pill. It is a situation whereby the managers do pose as if the company is so much that the firm is not attractive leading to the takeover of the firm. The managers might also try to repurchase shares from an individual thus possessing more control of the firm. Such actions will affect the credit providers, therefore, resulting in agency problem in the corporate company.

In conclusion, in the contemporary world, it is significant for the firms to come up with different ways of identifying agency problems within their firms. Having have identified the source of agency problem; then they will be in a better position to come up with solutions to handle the agency problem that faces them. Moreover, they will know how they will balance the conflict of interest that exists between different plays which make sure that the company runs effectively. A well handles agency relationship will ensure all parties are contented with the results and work to the attainment of the other party`s interest without pursuing their interest.   

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