Agency Costs in Management

Monitoring Costs

• Costs incurred by principals to monitor the actions of agents
• Can include audits, internal controls, and oversight by boards of directors

Bonding Costs

• Example: An executive signing a non-compete agreement after leaving a company to prevent them from using confidential information for a competitor

Residual Losses

• Potential Result: Reduction in shareholder value or profitability

Mitigating Agency Costs

• Strategies: Performance-based compensation, independent boards of directors, and strong corporate governance structures

Executive Benefits at Expense of Shareholders

• Agency Cost: Excessive compensation, perks, and self-serving decisions

Shirking

• Concept: Agents putting in less effort than agreed upon, potentially due to lack of monitoring or weak incentives

Excessive Risks

• Practices: Taking on too much debt, overextending investments, and ignoring risk management

Consequence of Accounting Fraud

• Outcome: Loss of investor trust, legal penalties, and potential business failure

VOC Internal Challenge

• Challenge: Controlling the actions of agents (employees) who were often located far from headquarters

VOC Agency Problem Solution

• Counteract: Established a complex system of internal controls, monitoring, and reporting

Current Corporate Governance

• Ensures: Shareholders have a voice in company decisions, and their interests are protected

Board Diversity

• Non-Contributing Aspect: Gender, race, or ethnicity alone do not guarantee diverse perspectives

CEO Compensation Alignment

• Component: Performance-based compensation, like stock options or bonuses

Corporate Governance Mechanism

• Type: Independent boards of directors, focusing on monitoring and advising management

Financial Disclosure Process

• Outcome: Increased transparency and accountability for companies

Shareholder Activism

• Concept: Shareholders actively engaging with companies to influence corporate governance and decision-making

GAAP Financial Disclosure Purpose

• Primary Purpose: To provide investors with accurate and reliable information about a company's financial performance

SOX Auditor Requirement

• Requirement: Auditors must assess and report on the effectiveness of a company's internal controls

Issuer-Paid Rating Agency

• Type: Credit rating agencies, where the company being rated pays for the assessment

Financial Crisis Impact on Rating Agencies

• Impact: Criticism of rating agencies' methods and standards due to their role in the crisis

ESG Rating Agencies

• Characteristic: They assess companies based on environmental, social, and governance factors

Audit Quality Influence

• Negative Factor: Auditor independence, conflicts of interest, and pressure from clients

Voluntary Non-Financial Disclosure

• Type: Sustainability reports, social responsibility statements

Governance Rating Agencies

• Role: They assess companies' corporate governance practices and provide ratings to investors

Shareholder Theory Aim

• Primary Aim: Maximize shareholder wealth and profits

Shareholder Theory Proponent

• Proponent: Milton Friedman

Shareholder Theory Addressing Tensions

• Non-Suggested Method: Ignoring the interests of all stakeholders except shareholders

Company Effectiveness (Shareholder Theory)

• Measurement: Based on financial performance and return on investment for shareholders

Stakeholder Theory Focus

• Key Focus: Considering the interests of all stakeholders, including employees, customers, and communities

Shareholder Payoff (Shareholder Theory)

• Resemblance: A zero-sum game, where one party benefits at the expense of others

Shareholder Theory Criticism

• Criticism: It can lead to short-term profit maximization at the expense of long-term sustainability and social responsibility

Repeated Game (Shareholder Theory Tensions)

• Concept: Companies and stakeholders engage in ongoing interactions, leading to potential cooperation and compromise

Collective Action Challenge (Environmental Issues)

• Challenge: Coordinating the actions of multiple actors to address complex environmental problems

Jared Diamond Factor

• Factor: Proximity: The geographic proximity and interaction between societies influences their development and evolution

PG&E Bankruptcy

• Reason: Responsibility for wildfires, leading to legal liabilities and financial strain

Management and Leadership Characterization

• Characterized: By their focus on immediate profits over long-term sustainability and social responsibility

Pollution Reduction Conflict

• Conflict: Between the interests of individual countries in economic growth and the need for global cooperation to reduce pollution

This quiz explores the dynamics of agency costs, where principals and agents navigate their interests in corporate governance. Examine the roles of monitoring, signaling, and residual costs in ensuring alignment between shareholders and management. Test your knowledge on important concepts such as board oversight and shareholder activism.