Sources and Ramifications of Agency Problems - Essay Example

The sources and ramification of agency problems within the firm

In a corporate setting, the managers who are in charge of the firm will always act in the interest of the shareholders. The managers will always strive to make sure that they have attained the maximum shareholders' interest in the firm. Moreover, the managers will make sure their actions will ensure that they enhance the value of the stock. The level of management that is offered by the management depends on the size of the corporation (Mitnick, 2015). If the corporation is large, then the efficiency level in the management of the firm depends totally on the management of the managers and not the shareholders. On the other hand, if the size of the shareholders is small then the management of the firm will be done by both the managers and the shareholders. At the point where the management of the firm is done by the managers, we identify whether the managers will act in the best interest of the shareholders. Besides that, we realize that the managers will go on to pursue their interest at the expense of the interest of the shareholders.

Agency relationship always occurs in a corporation when the shareholders who are the principal hire the managers who are the agents to represent the shareholders in the achievement of the organizational goals and objectives (Bosse and Phillips, 2016). It this kind of a relationship, there will be a high probability of eruption of the conflict of interest between the two parties. This is the kind conflict we refer to as the agency problem. When the conflict is between the firm`s managers and the capital provider, then it will be an agency problem in a corporate setting. In this paper, we are going to identify the some of the sources that result in agency problem in a firm. Also, we are going to look at the ramification that agency problem might have to the company (Mitnick, 2015). Among the sources of the agency, problem includes how the manager is compensated by the shareholder, what level of control or attainment of the firm’s goals and objectives. In this paper, we are going to focus on the agency problem between the company`s managers and the company`s credit providers. We will at the factor that triggers the eruption of agency problem between the two parties in the operation of the firm.

The firm managers are concerned with their interests. They will give more focus to their wealth, fringe benefits and more salaries. On the other hand, the capital providers are the plays in a firm that provide capital to be used to run the various activities of the firm (Mitnick, 2015). The credit providers will want to make sure that their funds are properly utilized and yield the highest returns within the shortest time possible. The managers and the credit provider have a different interest in the place and this result in a conflict of interest between them. If the manager pursues their interest, then the consequences of their actions will result in the reduction of the credit providers` wealth and returns. The managers are always in a dilemma of either comprising their interest for the same of the credit provider`s interest. Because the managers have a better understanding of the company, then they will manipulate the data and figure to their advantage. Thus the managers will not work to the attainment of the credit providers’ interest because of less the compensation and rewards they are given to them by the credit providers.

In addition, the managers and the shareholder might have different forms of goals and objectives that they have planned for the company (Mitnick, 2015). The goals that the managers might not be supported by the shareholders and the inverse is also true. Such a situation will result in a conflict of interest within the two players thus resulting to agency problem within the firm. The firm might identify a lucrative business investment to undertake, and it happens that the same investment is so risky in that it will impact the firm. Conflict of interest will erupt within the firm between the managers and the shareholders. The shareholders will spire head the undertaking of the business investment as it will enhance their value within the firm thus rise in stock value. On the other hand, the managers will not support the business investment due to the risk associated with the investment (Bosse and Phillips, 2016). They will not support the project as things might not turn out as expected and it will affect the company. Many of the employees will lose their job as a result of the implication of the undertaken project thus managers not in support of the project. If the managers do not undertake the investment, then the shareholders will lose their stock value chance. Such a situation is a source of agency problem within the firm.

Furthermore, the agency problem within a corporate firm might be rampant between the managers and the credit providers when the managers seek more of glory and satisfaction than concentrating on higher returns. Managers might have the habit of giving their corporate earning that meant for the credit provider to enhance their glory and satisfaction among colleagues (Mitnick, 2015). The managers might not support the interests and the goals of the credit providers by them practicing the act of poison pill. A poison pill is a situation whereby the managers do pose as if the company is of much value thus gaining more attractiveness leading to the takeover of the firm. The managers might also try to repurchase shares from an individual thus possessing more control of the firm. Such actions will affect the credit providers, therefore, resulting in agency problem in the corporate company.

A good example of a company that demonstrates the issue of agency problem in the company is the Lehman Brother`s Company. The Lehman Brothers is a very good example of a corporate governance failure. The problem in the firm resulted due to conflict of interest between managers and the credit providers (Chen and Sougiannis, 2012). The managers of the Lehman Brother`s Company did not perform their duty of proper oversight thus the company failing to perform well due to agency problems. The managers of the Lehman Brother`s Company each owned a small portion of the company. On the other hand, the credit providers of Lehman Brother`s Company did have a small ownership in the portion of the company. The small ownership of the stock of the company made it difficult for the credit providers of Lehman Brother`s Company to solve the agency problem facing the company (Mitnick, 2015).

The managers of Lehman Brother`s Company having possessing a small percentage of the company`s stock did not give a guarantee that they will act on the best interest of the credit providers of Lehman Brother`s Company. The managers could not put aside their interests and manage the various risks that the company was facing. If the Lehman Brother`s Company was an incorporated firm like the limited liability partnership that requires the shareholders to put their capital, then the all the parties in the company could assume the unlimited liabilities facing the firm. Both the managers and the credit providers could take responsibility for the high risks that the company was experiencing (Chen and Sougiannis, 2012). The ability of Lehman Brother`s Company taking high risks is a classic illustration of the agency problem. The reason is that the managers of the company acted on their interest which was based on performance compensation.

The Lehman Brother`s Company to solve this type of agency problem between the managers and the credit providers had to come with a third party team referred to as the board of directors. The board of directors will have the task of identifying and monitoring the interests of the shareholders and the managers. Lehman Brother`s Company being a bid company the agency problem could not be solved by having the shareholders owning the largest proportion of the company. The company trades in the stock market and their shareholders change within such minutes. Thus the introduction of the board of directors was the best manner to tackle the agency problem facing the company (Chen and Sougiannis, 2012). The directors will be in charge of monitoring and incentivizing managers on behalf of the credit providers. Their other responsibility will be to act as the oversight body on the external audit of the firm, assessment of the firm`s governance structure and making crucial decisions that impact the operations of the firm. Such crucial decision includes the distribution of dividend to shareholders and the compensation of managers.

In the management of agency problem within a firm, when there is lack of adequate oversight and incentives which are aligned in the company`s structure then the issues of agency problem will occur in the firms (Mitnick, 2015). The biggest percentage of shareholders do fall into the same trap as the Lehman Brother`s Company because they have the mentality of taking their capital management outside the traditional banking system will enable them to reduce fees and thus to save more funds. A good banking system and institutions help organizations reduces a lot of risks thus a good why that company can adapt to reduce or avoid the issues that relate to agency problem (Chen and Sougiannis, 2012).

In conclusion, in the contemporary world, it is significant for the firms to come up with different ways of identifying agency problems within their firms. Having have identified the source of agency problem; then they will be in a better position to come up with solutions to handle the agency problem that faces them. Moreover, they will know how they will balance the conflict of interest that exists between different plays which make sure that the company runs effectively. A well handles agency relationship will ensure all parties are contented with the results and work to the attainment of the other party`s interest without pursuing their interest.

Reference

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