In: Finance
Explain how your selected tools are effective in resolving potential conflicts among managers and stockholders.
Agency problem arises due to conflict of interest between
promoters of company or stockholders and the management.
The conflict arises due to interest of stockholder to maximize
their own wealth whereas interest of manager will be to increase
their own wealth.
Two ways to prevent agency problems:
1. Performance linked pay and ESOPS: By
compensating for better share performance the manager can be
motivated to work towards shareholder wealth maximisation .
ESOP(Employee Stock options) are provided to employee so that they
can also benefit from increasing share value. Since management
donot want takeover bids by competitors due to job security issues
but higher pay and ESOPS can align their interests with the
shareholders.
2. This principal and agent conflict can be minimised by using
contracts and laws. The covenants help to legally
bind the mangers to performs according to wishes of the
shareholders. Any breach of contract can have monetary losses for
the manager which can deter managers to work against the
shareholders.