Presentation on theme: "The Principal-Agent Problem"— Presentation transcript:
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: PROFITCorporate Officers: POWER, PRESTIGE, PERSONAL WEALTHSenior managers may be in a position to enrich themselves at the expense of the shareholders.
4 Sales revenue maximising with a profit constraint TCTRPOQQ2Q3Q1Total profit
5 ALTERNATIVE MAXIMISING THEORIES Sales revenue maximisationequilibrium output and pricecomparison with profit-maximising output and priceeffect of a minimum profit constraintimplications for advertisingcomparisons with short-run profit maximisingimplications for the consumerassessment of the theory3
6 ALTERNATIVE MAXIMISING THEORIES Growth as a motive for firmsgrowth maximisationmeans of achieving growthGrowth by internal expansionsources of fundsthe takeover constraintGrowth by merger and take overtypes of mergermerger activity4
7 Agency TheoryAgency 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 TheoryAll agency relationships involve moral hazard.“the principal and the agent may have different objectives and the principal cannot easily determine whether the agent’s reports and actions are being taken in pursuit of the principal’s goals or self-interested behaviour.”
9 Agency TheoryInformational AsymmetryMonitoringThe Free Rider Problem
10 External Constraints on Managers The Product MarketThe Market for Corporate ControlThe Market for Managerial Labour
11 Internal Control Mechanisms Performance Related Payconcentrates the risk of agentspromotes short term profitshare options schemes are asymmetriccompensation committeessize does matter
12 Additional Control Mechanisms The Board of DirectorsMultiple Principals - the Role of the BanksManagerial Bonding: the Role of Debt