An agency problem is a relationship between an agent and owner. An agency relationship is a contract under which one or more people( The Principals) hire another person(The Agent) to perform some series and delegates authority to that agent. Growth of business size has increased the popularity of joint stock firms and as a result the distance between owners and managers has also increased. General shareholders elected Board of Director (BOD) and remaining managers and human resources are appointed by BOD such situation may differ the interest between them and such conflict or difference is agency problem. Agency Problem may be defined as a potential conflict for own interest between Shareholders vs Managers and Shareholders vs Debt holders(Creditors)
a) Shareholders vs Managers = A potential agency problem arises whenever the owner and manager represent different existence and the manager of the firm owns less than 100% of the firm's common stock. The manager wants to take high salary, enjoy much more facilities like car, mobile, insurance, apartment etc , as well as more relaxed time(less working hours). But shareholders interest will be maximize their wealth and may hesitate to fulfill the desire of managers. Fulfillment of one's interest will negatively affect others and hence there arises conflict between Shareholders and Managers.
Ways to avoid agency problems
a) Monitoring the managerial activities
b) Provision of cash kind incentives to managers.
c) Provision of stock option and stock bonus
d) Limitation of managerial autonomy
e) Threat of firing
f) Takeover threat
g) Replacement
b) Shareholders vs Debt holders = Shareholders and Debt holders have different rights and returns. Debt holders enjoy fixed interest rate and shareholders enjoy rest of the income of the firm. Shareholders wants to use more debt for capital increment and debt holders does not want to give more funds. Debt holders wants to invest in low risk sector and shareholders wants to invest in high risk sector( High risk and high return). Debt holders wants to establish sinking provision fund but shareholders don't establish it. These changes in interest arises the conflict between Shareholders and Debt holders.
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