Agency and Conflict of Interests
buttons.Managers, Shareholders, and Bondholders
The agency view of the corporation
posits that the decision rights (control) of the corporation are
entrusted to the manager to act in shareholders' and other stakeholders' interests. Partly as a result of this separation, corporate governance
mechanisms include a system of controls intended to help align
managers' incentives with those of shareholders and other stakeholders.
The agent's deviation from the principal's interest is called "agency costs." Agency costs mainly arise due to contracting costs, the divergence of control, the separation of ownership and control, and the different objectives of the managers and other stakeholders.
Three parties key to the functioning of the corporation
are the managers, shareholders, and bondholders. These three parties
have different interests and asymmetric information, so the principals cannot directly ensure that the agents always act in their (the principals') best interests. Moral hazard and conflict of interest may arise.
Working on Assignments
While managers control the corporation and make strategic
decisions, shareholders are owners, and bondholders are creditors. While
all three parties have an interest, whether direct or indirect, in the corporation's financial performance, each has different rights and rewards, such as voting rights and forms of
financial return.
Shareholders, managers, and bondholders have different objectives. For example, stockholders have an incentive to take on riskier projects than bondholders do, as bondholders are more interested in strategies that will increase the chances of getting their investment back. Shareholders also prefer that the company pay more out in dividends than bondholders would like. Managers may also be shareholders and reap the profits of more risky strategies or may prefer risk-averse empire-building projects.
Key Points
- Three parties key to the functioning of the corporation are the managers, shareholders,
and bondholders. While managers control the corporation and make
strategic decisions, shareholders are owners, and bondholders are creditors.
- While all three parties have an interest,
whether direct or indirect, in the financial performance of the
corporation, each of the three parties has different rights and rewards,
for example voting rights and forms of financial return.
- Shareholders, managers, and bondholders have different objectives. For example, shareholders have an incentive to take riskier projects than bondholders do and may prefer that the company pay more out in dividends. Managers may also be shareholders or prefer risk-averse, empire-building projects.
Terms
- Bond – A documentary obligation to pay a sum or to perform a contract; a debenture.
- Dividend – A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).
- Moral Hazard – The prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.