Question

Shareholders are the owners of a corporation, yet they do not manage the firm. This results in a principal-agent problem. The firm's managers (agents) are expected to act in the interest of the firm's shareholders (principals). When might interest not align? Can you provide a specific example?

Answer 1

An example of agency problem can be-

A. when the managers are trying to maximize the profits because profit maximization is the ultimate goal of the managers as profit maximization will be securing their own interest and their own job but in process of maximizing the profits, it can be often seen that managers are entering into excessive risk taking which are endangering the long-term existence of the company and which are also endangering the shareholders fund in the company so this can lead to conflict of interest because the profit maximization goals are prioritised by the managers,rather than maximisation of the shareholders value so it can be said that managers can be trying to inflate the profits whereas, shareholders will always want to inflate the share price and that can lead to conflict of interest.

Similar thing happened in case of Lehmyan brothers, in which Richard dickfuld generally indulged into such excessive risk taking that the business did not survive during economic downturn and it lead to erosion of the capital of the shareholders.