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Corporate Finance Essay

1674 words - 7 pages

To what extent is it true that as a result of agency costs shareholders wealth will not be maximized by corporate management. If so, what actions can shareholders take to correct the situation?





As we know that agency costs exists in most corporations since the separation of ownership and management in large businesses. Shareholders are the principals and owners; managers are the stockholders’ agents. The problem is to get between shareholders and managers since they have different objectives. Shareholders’ goals are maximizing firms’ value, managers’ goals are benefit themselves, thus the conflicts rise in the company. In this report through concept of agency ...view middle of the document...

Shareholders want to take the project since that has opportunity to increase the value of the firm, but manager may get blame once the project is not successful. At this situation the agency costs are incurred.

Brealey (2006) noted that agency costs are incurred when managers do not attempt to maximize firm value and shareholders incur costs to monitor the managers and influence their actions. Of course, there are no costs in a sole proprietorship when the shareholders and managers are same person. In corporations principal-agent conflicts arise in a number of ways. First they have different objectives between shareholders and managers. Shareholders’ goals are that maximize firm’s wealth; managers’ goals are that maximize their own self –interests or increase employee benefits and increase the size of the company so that improve their job security. Second, as managers consequently running the company on a day-to-day basis, have access to accounting data and financial reports, where shareholders only receive annual reports. Managers may hide information from shareholders; hence shareholders need monitor the managers’ effort and actions.

The view proposed by Brealey (2006) that agency problem in corporations are not only principal-agent problems that the financial manager is likely to encounter. For example, shareholders encourage managers to work for the shareholders’ interests; senior managers need to think how to motivate everyone else in the company. Hence senior managers are the principals and junior managers and other employees are the agents. There are various conflicts between managers’ decisions and shareholders’ interests. For example (Boundless), managers may buy other companies to expand power; or venture onto fraud that they may even manipulate financial figures to optimize bonuses and stock-price-related options.

Agency costs are also arose in other areas that as a result are truly effect shareholders maximizing wealth by corporate management. Early contributions by Jensen (1986) at agency theory, the analysis of such agency costs are becoming a major part of problem. Shareholders invest money to company; they expect the money return. The payout of money to shareholders creates major conflicts since that reduce the managers’ power and control. This makes it more likely managers will incur the monitoring of the capital markets which occurs when the firm must obtain new capital (Easterbrook, 1984, and Rozeff, 1982). Financing projects internally avoids this monitoring and intends to reduce the conflicts. Managers have incentives to cause the firms to grow the optimal size and wealth value. Growth increases managers’ power by the increasing resources, hence increases managers’ control.

Although agency costs are happened in many corporations, shareholders can still maximize their wealth by motivating managers to act in shareholders’ best interests. According to Berk (2007), these primary mechanisms...

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