Gdb solution acc501 business finance fall 2012

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Agency Problems(Principal-agent problem or Agent- principal problem):

This is the problem of designing mechanisms that will induce agents to act in their principals'

interests. In general, unless there is costly monitoring of agents' behavior, the problem cannot be

completely solved. Hired managers will generally wish to pursue their own goals. They cannot

ignore profits, however, because if they perform badly enough they will lose their jobs. Just how

much latitude they have to pursue their own goals at the expense of profits depends on many

things, including the degree of competition in the industry and the possibility of takeover by

more profit-oriented management.

The principal-agent problem arises within the firm when ownership and control are separated

and the self-interest of managers may lead them to act other than in the interest of the

shareholders.

Generally Incurred costs and aligned "Agent-principal" goals:

The Principal can limit divergences from his interest by establishing appropriate incentives for

the agent and by incurring monitoring costs designed to limit the aberrant activities of the agent.

In addition in some situations it will pay the agent to expend resources (bonding costs) to

guarantee that he will not take certain actions which would harm the principal or to ensure that

the principal will be compensated if he does take such actions.

However, it is generally impossible for the principal or the agent at zero cost to ensure that the

agent will make optimal decisions from the principal’s viewpoint. In most agency relationships

the principal and the agent will incur positive monitoring and bonding costs (non-pecuniary as

well as pecuniary), and in addition there will be some divergence between the agent’s decisions

and those decisions which would maximize the welfare of the principal. The dollar equivalent of

the reduction in welfare experienced by the principal as a result of this divergence is also a cost

of the agency relationship, and these costs can be referred as the “residual loss.” and Agency

costs can be defined as the sum of:

1. the monitoring expenditures by the principal.

2. the bonding expenditures by the agent.

3. the residual loss.

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Agency Problems(Principal-agent problem or Agent- principal problem): This is the problem of designing mechanisms that will induce agents to act in their principals' interests. In general, unless there is costly monitoring of agents' behavior, the problem cannot be completely solved. Hired managers will generally wish to pursue their own goals. They cannot ignore profits, however, because if they perform badly enough they will lose their jobs. Just how much latitude they have to pursue their own goals at the expense of profits depends on many things, including the degree of competition in the ...
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