Essay by EssaySwap ContributorUniversity, Master's February 2008

download word file, 5 pages 3.0

Question 1: a.

Principal-agent conflicts between owners and managers because the interests of managers are not generally aligned with those of owners. The owners¡¯ interests are to maximize their own wealth. The managers are their agents, hired to make decisions on the owner¡¯s behalf. They only own small fraction of the firm¡¯s equity, which provides them with little incentive to maximize firm¡¯s value. So, facing the very little equity owned, the managers have strong incentives to consume perquisites. If significant benefits associated with the control of a corporation, including a large salary, office perquisites, and prestige, those self-interested managers will bias their decisions about the firm¡¯s financing and investments to preserve their control and enhance their benefit. Such as managers may choose for the firm to invest in projects where the manager¡¯s personal relationships with other parties to the project are critical to the project¡¯s successful completion. The manager at the retiring age might not be willing to take a big long-term +NPV investment project if their bonus, stipend scheme is closely related to the performance of the year.

The huge initial investment might influence current year¡¯s profitability, which results the decrease in the manager¡¯s income. As above, in making decisions, managers would make trade off among three constituencies. They would not try to maximize shareholder value only. Consequently, the conflicts between the parties occur.

b. (i) Monitoring by financial institutions. Bank debt is widely held, it can eliminate the free-rider problems especially in reducing the free-rider problem with respect to monitoring the firm¡¯s management. Also it makes the bank has strong incentive to monitor the firm¡¯s performance, which indirectly reduces owner-manager agency costs.

(ii) Monitoring by large ¡°block-holders.¡± Large shareholders have sufficient incentive to actively monitor firm management and also have better and cheaper access to information about...