Question

A) What is the fundamental goal of financial management? 

B) Explain agency theory and agency problems between stockholders and managers AND solutions. Also explain the potential conflict between stockholders and bondholders. 

Answer 1

1. A Fundamentals Goal Of Financial Management

If we were to consider possible financial goals, we might come up with some ideas like the following:

Survive.

Avoid financial distress and bankruptcy.

Beat the competition.

Maximize sales or market share.

Minimize costs.

Maximize profits.

Maintain steady earnings growth.

B. Agency Theory And Agency Problems Between Stockhonders and Managers

An agency relationship occurs when a principal hires an agent to perform some duty. A conflict, known as an "agency problem," arises when there is a conflict of interest between the needs of the principal and the needs of the agent.

Stockholders versus Managers

• If the manager owns less than 100% of the firm's common stock, a potential agency problem between mangers and stockholders exists.
• Managers may make decisions that conflict with the best interests of the shareholders. For example, managers may grow their firms to escape a takeover attempt to increase their own job security. However, a takeover may be in the shareholders' best interest.

Solutions

a. Efficiency in Wage rate

b. Monitoring action of agent

c. Good incentive plan

d. Cordinating Management

Potential Conflict between stockholders and bondholders

A tension exists between the stockholders and bondholders of a company. For example, if stockholders use their control to pay themselves high dividends, thus weakening the company's ability to pay its debts as they come due, the value of bonds falls. Likewise, if a company takes on a heavy debt burden, swamping it with interest obligations, stockholders may not be paid dividends.

Bondholders and stockholders may have interests in a corporation that conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective covenants in bond documents work toresolve these conflicts.