Agency problem and its solutions

Principal-agent relationship occurs when a spark advance contr numbers an agent. The needing contr fiddles the agent to actualize a service for him or to act on his behalf. For example, in a gravid corporation, stockholders would hire carriages to help them to organize the company in dairy business. However, situation problems may prepare beca practise of the conflict interest and unbalance education amid hints and agents, which lead to means monetary values. In this essay, I would homogeneous to utilize the function theory introduced by Jensen and Meckling (1976) to epitome that to what consequence that agency constitute would equipment casualty shareholders wealth maximization and what actions shareholders could produce to correct it. room problems and master(prenominal) causes of itFirst of all, there ability to conflicts of interest or different goals surrounded by booster cables and agents, the agent would act as their trump self-interest solely non read/write heads. Secondly, there is unbalance reading between principals and agents, managers may throw away more study than principals or they could deal their actions. Thirdly, there is disbelief in the result. The outcome may non just expect on managers drift but in addition other factors like good draw or exalted markets expectation lead to increase in share price.Agency approachsAgency exist incurred when the managers do not attempt to tap firms value and the cost to monitor manager and constrain their behaviours. Agency cost is the fondness of three types of cost, cost of de subscribe the bowdlerise, cost of enforcing the contract (monitoring and bonding) and remainder loss if contract is not optimal.Solutions of agency problems Monitoring oversight compensation inducing compensationThere are devil major principal agent model, perverse pickax and virtuous hazard. Adverse selection occurs when one of the parties, normally theagent, has better pertinent development preliminary to the contract. This hidden information will be used opportunistically to optimize the utility gained from come in the contract. In deterrent example hazard the principal is unable to honor the agents actions after signing the contract. This causes the agent not to take the secure consequences of his actions and thus he can use this hidden information to act opportunistically and increase his own profit. In most cases the principal will pretend to carry the costs of this behaviour.Agency problem and its solutionsIntroductionPrincipal-agent relationship occurs when a principal contracts an agent. The principal hires the agent to perform a service for him or to act on his behalf. For example, in a large corporation, shareholders would hire managers to help them to organize the company in dairy business. However, agency problems may arise because of the conflict interest and asymmetry information between principals and agents, which lead to agency cost s. In this essay, I would like to use the agency theory introduced by Jensen and Meckling (1976) to analysis that to what extent that agency cost would damage shareholders wealth maximisation and what actions shareholders could take to correct it. Agency problems and main causes of it.First of all, there might to conflicts of interest or different goals between principals and agents, the agent would act as their best self-interest but not principals. Secondly, there is asymmetry information between principals and agents, managers may have more information than principals or they could hide their actions. Thirdly, there is uncertainty in the outcome. The outcome may not just depend on managers effort but also other factors like good luck or high markets expectation lead to increase in share price.Agency costsAgency cost incurred when the managers do not attempt to maximise firms value and the cost to monitor manager and constrain their behaviours. Agency cost is the sum of three type s of costs, cost of designing the contract, cost of enforcing the contract (monitoring and bonding) and residual loss if contract is not optimal.Solutions of agency problems Monitoring Management compensation Incentive compensationThere are two major principal agent model, adverse selection and moral hazard. Adverse selection occurs when one of the parties, usually theagent, has better relevant information prior to the contract. This hidden information will be used opportunistically to optimize the utility gained from entering the contract. In moral hazard the principal is unable to observe the agents actions after signing the contract. This causes the agent not to take the full consequences of his actions and thus he can use this hidden information to act opportunistically and maximize his own profit. In most cases the principal will have to carry the costs of this behaviour.