Agency problem

Definition

The agency problem arises when there's a conflict of interest between the management (agents) and the shareholders (principals) of a corporation. This issue can lead to managers making decisions that benefit themselves at the expense of shareholders.

5 Must Know Facts For Your Next Test

1. The agency problem is often addressed through incentive schemes like stock options.
2. Corporate governance mechanisms such as boards of directors help mitigate agency problems.
3. Monitoring costs are incurred by shareholders to oversee managerial actions.
4. Agency problems are more likely in companies with dispersed ownership.
5. Regulations and laws, like Sarbanes-Oxley Act, aim to reduce agency conflicts.

Review Questions

• What is the primary cause of the agency problem?
• Name one method used to align the interests of managers and shareholders.
• How do corporate governance mechanisms help in mitigating the agency problem?

Related terms

Principal-Agent Relationship:

A relationship where one party (agent) acts on behalf of another party (principal).

Corporate Governance:

The system by which companies are directed and controlled, involving regulations and practices.

Incentive Alignment: Strategies used to align the interests of agents with those of principals, such as performance-based bonuses.