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a In proprietorships, partnerships owners are actively
involved in management.

a But in companies, especially large public limited

companies, owners are typically inactive managers.

a They entrust this responsibility to professional managers

who may have little or no stake in the firm.

a This is the main reason for conflicts between managers

and owners of the company.
a Rost enterprises require large sum of capital to achieve
economies of scale. Hence it becomes necessary to pool capital
from thousands of owners. It is impractical for many owners to
participate actively in management.
a ’rofessional managers may be more qualified to run the
business àecause of their technical expertise , experience and
personality traits.
a Àeparation of ownership permits unrestricted change in owners
through share transfers without affecting the operations of the
firm.
a ×iven uncertainties , investors would like to hold a diversified
portfolio of securities. Àuch diversification is achievable only
when ownership and management are separated.
 n agency relationship arises whenever one or more
individuals, called ›

›,
(1) hires another individual or organization, called an
 , to perform some service and
(2) then delegates decision-making authority to that agent.
a  potential agency problem arises whenever the manager of
a firm owns less than 100 percent of the firm¶s common
stock, or the firm borrows. ou own 100 percent of the firm.
n agency problem could exist between you and your
employees if you, the principal, hired the employees to
perform some service and delegated some decision-making
authority to them.

a cquiring outside capital could lead to agency problems.

a The gent is responsible for acting on behalf of the
principal. Its highly possible that agent will act in his or
her personal interest because the agent has his or her
own objective of maximizing personal wealth.
a In large corporations the mangers enjoy fringe benefits.
These benefits may be helpful to conduct business and
may help to retain or attract management personnel.
There is a possibility that managers who feel secure in
their positions may not àother to expend their àest
efforts toward the àusiness.
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a n 
  is an economic concept that relates to the cost
incurred by an entity (such as organizations) associated with
problems such as divergent management-
shareholder objectives and information asymmetry. The costs
consist of two main sources:
a The costs inherently associated with using an agent (e.g., the
risk that agents will use organizational resource for their own
benefit) and
a The costs of techniques used to mitigate the problems
associated with using an agent (e.g., the costs of
producing financial statements or the use of stock options to
align executive interests to shareholder interests).
a gency costs refer to the costs of the conflict of
interest between stockholders and management.
a These costs may be direct or indirect.
a 

 
Two forms
G The first type is a corporate expenditure that benefits
management but costs stockholders. ’erhaps purchase
of a luxurious and unneeded corporate jet .
G The second type is and expense that arises from the
need to monitor management actions. E.g. paying
outside auditors to assess the accuracy of financial
statement information.
a It is a lost opportunity.
a Ranagement may fight acquisition of their firm by
other firm even if the acquisition would benefit
shareholders.
a Because in most takeovers, management personnel
loose their jobs.
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a The security market participants / Àhareholders and large
institutional investors like mutual funds , insurance
organizations which hold large blocks of shares of
corporate actively take part in management.
a They exercise their voting rights to replace more
competent management in place of under-performing
management.
a They also from time to time communicate with, and
exert pressure on corporate management to perform or
face replacement.
a cquisition of firm by another firm that is not
supported by management.
a Àuch takeover typically occur when the acquirer is of
the view that the target firm is undervalued due to
poor management and that its acquisition will value
the firm by restructuring its management , operations
and financing.
a The constant threat of a takeover will motivate
management to act in the best interests of the owners
despite the fact that techniques are available to
defend against a hostile takeover.
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a They protect the owners against the potential
consequences of dishonest acts by management/
mangers.
a The firm pays to obtain 


from a third
party bonding company to the effect that the latter will
compensate the former up to a specified amount for
financial losses caused by dishonest acts of managers.
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a They relate to structuring managerial compensation to
correspond with share price maximization.
a The objective is to offer incentives to management to
act in the best interest of the shareholders.
a The restructured higher compensation packages to
managers also enable corporate to hire the best available
managers.
a uall into two groups:
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2
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:They tie management compensation
to share price .Rost widely used incentive plan is



















 

.  high future price would result in larger management
compensation.
a These plans compensate management on the basis of its
proven performance measured by E’À, growth in E’À
and other ratios related to return!
a Based on these ,performance shares may be given to
management for meeting the stated performance goals.
a nother form of performance based compensation is
cash bonuses that is, cash payments tied to the
achievement of certain performance goals.