AGENCY CONFLICTS

In financial terms an agency conflict occurs when there is a conflict of interests

between two parties in a company. This conflict arises between the shareholders
of the company and the management. A managers primary duty is to ensure the
maximization of the shareholders wealth. However managers at times tend to
perform actions beneficial to their own interests which results in agency conflicts.

AGENCY CONFLICTS: CREDITORS AND

SHAREHOLDERS
The conflict between a companys shareholders and the creditors is through the
management of the company. Creditors of any company have a right to a part of
a companys income in form of interests as well as the principal sum. In the
event of a bankruptcy of the company the creditors also have the primary claim
on the companys assets. However management of any company is supervised
by its shareholders who influence a lot of decisions and operations which are
carried out in an organization. When creditors lend out capital to a company they
make their own estimates of the rates and take a lot of factors into account
including:
1.
2.
3.
4.

Risk involved on the companys assets

Expectation of risk carried by assets purchased in future
The companys current capital structure
Expected future capital structure decisions

Shareholders on the other hand keep pushing the management to take riskier
decisions which will call for a higher required rate of return which will result in
the value of the debts outstanding to fall. Shareholders here act in their own
personal interest and a successful risky investment will provide them with a
bigger return because of the increase in profits. Creditors however will have no
gain here since they are provided returns on a fixed rate. However in case of an
unsuccessful investment the creditors will have to bear the loss, which shows us
that the shareholders benefit in any case.
Managers also at times borrow more funds in order to repurchase the firms
outstanding stocks, this is mainly to leverage up the shareholders return on
equity. The value of the debt will here most probably decrease since there will be
a higher number of creditors who have a claim against a firms cash flows as well
as the assets. The shareholders thus ultimately benefit from both the riskier
asset situation as well as the increased leverage transaction.
Shareholder creditor agency conflicts often result in situations where a firms
total value declines however its stock price does rise. This mainly happens when
the value of the firms outstanding debt falls by more than the increase in the
value of the firms common shares. If shareholders adopt methods to steal the
creditors wealth the bondholders will take measures to protect themselves which
will eventually hinder the performance of a company. If creditors are under a

belief that the management of the firm is trying to take undue advantage of
them, they will either refuse to provide additional funds to the firm or will charge
an above market interest rate to compensate for the risk of possible
expropriation of their claims. Therefore firms which deal with creditors in an
inequitable manner are likely to be cut off from the debt market or be charged
higher interest rates.

AGENCY
CONFLICTS
CREDITORS AND
SHAREHOLDERS

SUBMITTED TO MS MISBAH
IQBAL

BY: MUHAMMAD ABDULLAH ZUBAIR (10097)