AdvancedCorporateFinanceFINA7330RonaldF.Singer.pptVIP

Advanced Corporate FinanceFINA 7330Ronald F. Singer Agency Problems and Control Lecture 4 Fall, 2010 Agency Problem The Principal-Agent Relationship Typically in a Corporation, there are what is called agents and principals: The Agent is the “person that acts,” whereas the Principal is the person that receives the benefits from the actions. Typical Principal/Agent relationships: The Agency Problem tries to solve the natural conflict of interest that arises as a result of this principal agent problem Conflicts of Interest Reduced effort on the part of the agent Excessive perks consumption Empire building Entrenchment Risk avoidance Agency Problem How do you resolve these conflicts? Monitoring Stockholders Bondholders Board of Directors Financial Press SEC and other government regulators Outside auditors Issues opinion regarding whether reports are consistent with generally accepted accounting standards Qualified or unqualified opinion Agency Problem Incentives Provide a compensation package to managers that try to induce them to act in stockholders’ interest Can’t determine this directly Difficult to separate effort from luck Usually this is performance (or value) based incentives Stock options Agency Problem Problems with value based compensation Difficult to distinguish between effort and competence, versus luck Could be subject to manipulation Enron, Fannie Mae, Stock options backdating scandal Compensation determined by Board Sarbanes Oxley: SOX: Compensation Committee must be independent directors Agency Problem The Basic problem is how do you measure performance, and how do you get information that is unbiased? You get what you measure Incentive Issues Monitoring - Reviewing the actions of managers and providing incentives to maximize shareholder value. Free Rider Problem - When owners rely on the efforts of others to monitor the company. Management Compensation - How to pay managers so as to reduce the c