Agency Costs in Management

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Questions and Answers

What are monitoring costs in the context of agency costs?

Costs incurred by principals to oversee agents' activities. (correct)

Costs for managers to enhance the firm's profitability.

Losses due to conflicts of interest between principals and agents.

Costs incurred by agents to disclose their actions.

Which of the following is an example of bonding costs?

Audit costs related to financial statement accuracy. (correct)

Marketing expenses to attract new investors.

Time spent in board meetings.

Costs associated with shareholder activism.

What is a potential result of residual losses in agency costs?

Enhanced transparency in operations.

Decreased overall welfare for principals. (correct)

Increased shareholder dividends.

Improved management performance.

Which of the following strategies can be employed to mitigate agency costs?

Activism by large shareholders to influence management. Signup and view all the answers

Which agency cost is associated with executives enhancing their personal benefits at the expense of shareholders?

Management entrenchment. Signup and view all the answers

What does the term 'shirking' specifically refer to in agency costs?

The tendency of executives to slack off if not supervised. Signup and view all the answers

Which of the following practices can result in excessive risks by management?

Empire building. Signup and view all the answers

What could be considered a consequence of accounting fraud in an organization?

Higher agency costs due to loss of reputation. Signup and view all the answers

What was a significant internal challenge faced by the VOC?

Traders unlawfully trading for personal profit Signup and view all the answers

How did the VOC attempt to counteract the agency problem within the company?

By increasing compensation linked to investments and sales Signup and view all the answers

What does the current corporate governance structure commonly ensure regarding shareholders?

Shareholders appoint independent auditors Signup and view all the answers

What aspect of board composition does NOT contribute to board diversity?

Board size Signup and view all the answers

Which component of CEO compensation is meant to align executive rewards with company performance?

Stock options Signup and view all the answers

Which type of corporate governance mechanism focuses on the monitoring and advising of management?

Board of directors Signup and view all the answers

What is a common outcome of a financial disclosure process?

Increased stakeholder trust Signup and view all the answers

Which of the following best represents the concept of shareholder activism?

Shareholders influence company decisions through voting and proposals Signup and view all the answers

What is a primary purpose of financial disclosures according to GAAP?

To improve transparency to stakeholders Signup and view all the answers

What is one requirement of the Sarbanes-Oxley Act (SOX) regarding auditors?

Auditors are prohibited from cross selling Signup and view all the answers

Which type of rating agency is paid by the issuing company?

Credit rating agencies Signup and view all the answers

What impact did the financial crisis of 2008 have on credit rating agencies?

They faced increased regulation Signup and view all the answers

Which of the following is a characteristic of ESG rating agencies?

They provide ratings based on ESG impacts to profitability Signup and view all the answers

What factor can negatively influence audit quality?

Time pressure on audit teams Signup and view all the answers

Which type of non-financial disclosure is typically voluntary?

Environmental sustainability reports Signup and view all the answers

What is the role of governance rating agencies?

To evaluate corporate governance quality Signup and view all the answers

What is the primary aim of Shareholder Theory?

To maximize the value for shareholders Signup and view all the answers

Who is primarily associated with the proponent of Shareholder Theory?

Milton Friedman Signup and view all the answers

Which of the following is NOT a suggested method for addressing tensions in Shareholder Theory?

Employees can file lawsuits Signup and view all the answers

According to Shareholder Theory, how should a company measure its effectiveness?

By revenues minus costs, which equals profit Signup and view all the answers

What is a key focus of Stakeholder Theory compared to Shareholder Theory?

Broader consideration of affected parties Signup and view all the answers

In Shareholder Theory, what does shareholder payoff resemble?

A call option Signup and view all the answers

Which statement accurately reflects a criticism often associated with Shareholder Theory?

It disregards employee interests entirely. Signup and view all the answers

What does the concept of 'repeated game' signify in the context of resolving tensions in Shareholder Theory?

It suggests that ongoing relationships impact future interactions. Signup and view all the answers

What is the primary challenge highlighted regarding collective action on environmental issues?

Tragedy of the commons Signup and view all the answers

Which of Jared Diamond’s factors relates to the interactions between societies?

Relationship with neighboring societies Signup and view all the answers

Why did Pacific Gas and Electric go bankrupt?

Causing forest fires Signup and view all the answers

How are management and leadership characterized in the context provided?

Management is problem-oriented while leadership is opportunity-oriented Signup and view all the answers

What major conflict is presented between the countries in relation to pollution reduction?

Conflict of interests regarding pollution reduction efforts Signup and view all the answers

Study Notes

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

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Description

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.