The Principal-Agent Problem

1
The Principal-Agent Problem

• Ownership control the large corporation is
  owned by so many shareholders that no single
  shareholder owns a significant proportion of the
  outside stock. Therefore no single shareholder
  has the power to really control the actions of
  the officers of the corporation.
• Negligence and profusion must always prevail
  in such a company.

2
The Principal-Agent Problem

• The bulk of the dividends go to outside
  shareholders.
• All the major decisions are taken by the
  corporate officers.
• The outside shareholders are unable to control
  the corporate officers.
• The interests of the shareholders and the
  corporate officers diverge significantly.

3
The Principal-Agent Problem

• Shareholders PROFIT
• Corporate Officers POWER, PRESTIGE, PERSONAL
  WEALTH
• Senior managers may be in a position to enrich
  themselves at the expense of the shareholders.

4
Sales revenue maximising with a profit constraint

TC
TR
P
O
Q
Q3
Q1
Q2
Total profit
5
ALTERNATIVE MAXIMISING THEORIES

• Sales revenue maximisation
• equilibrium output and price
• comparison with profit-maximising output and
  price
• effect of a minimum profit constraint
• implications for advertising
• comparisons with short-run profit maximising
• implications for the consumer
• assessment of the theory

6
ALTERNATIVE MAXIMISING THEORIES

• Growth as a motive for firms
• growth maximisation
• means of achieving growth
• Growth by internal expansion
• sources of funds
• the takeover constraint
• Growth by merger and take over
• types of merger
• merger activity

7
Agency Theory

• Agency theory in its simplest form discusses the
  relationship between two (or more) people, a
  principal and an agent who makes decisions on
  behalf of the principal.
• Owners of firms and their managers.
• Patient-doctor.
• Managers and their subordinates.

8
Agency Theory

• All agency relationships involve moral hazard.
• the principal and the agent may have different
  objectives and the principal cannot easily
  determine whether the agents reports and actions
  are being taken in pursuit of the principals
  goals or self-interested behaviour.

9
Agency Theory

• Informational Asymmetry
• Monitoring
• The Free Rider Problem

10
External Constraints on Managers

• The Product Market
• The Market for Corporate Control
• The Market for Managerial Labour

11
Internal Control Mechanisms

• Performance Related Pay
• concentrates the risk of agents
• promotes short term profit
• share options schemes are asymmetric
• compensation committees
• size does matter

12
Additional Control Mechanisms

• The Board of Directors
• Multiple Principals - the Role of the Banks
• Managerial Bonding the Role of Debt