Principles of Corporate Finance—Chap012.pptVIP

The ROI: return on investment rate menus minimal required discount rate r * * (Cash flow+PV end)/1.1=PV start Chapter 12 Agency Problems, Compensation, and Performance Measurement McGraw-Hill/Irwin Topics Covered Incentives and Compensation Measuring and Rewarding Performance: Residual Income and EVA Bias in Accounting Measures of Performance The Principal Agent Problem Shareholders = Owners Managers = Employees Jensen M.C. Meckling W. H .1976 Theory of the firm: Managerial behavior, agency costs and ownership structure, JFE, 3(4) 305-360 Causes of Principal-agent problem: Ownership and operation authorities are separated Information asymmetry Conflicts of interests between Principal and Agent The Principal Agent Problem The principal–agent problem: One person or institution(agent) is able to make decisions on behalf of another person or institution (principal) Agency costs: the costs that the principal incurs when dealing with an agent Actions of agents: Moral hazard: when the principal cannot monitor the agent actions, while the interest of agent is diverged from principal Employees do not work hard Incentive Bypass Problems Too many projects for top management to analyze Details are beyond the view of managers Many decisions are not in the capital budget (HR assignment) Small decisions add up to be large influencing Executives are also subject to human error Incentives Reduced effort: lack of monitoring results in little efforts for work Perks: personal interests Empire building: expansion without considering NPV rule Asian Financial Crisis: because banks believed that they were “too big to fail,” they made excessively risky loans. Entrenching investment: reinvestment in projects that CEO is familiar with Agency Problems in Capital Budgeting Incentive Issues Monitoring - Reviewing the actions of managers and providing incentives to maximize shareholder value. Monitors: Shareholders, board directors, lenders, auditors, security analysts, rival compa