Question

What is potential for principal-agent problems for Disney?

Answer 1

In corporate world the principal-agent problem is a situation of strife or conflict in priorities between the owner or owners of the firm and the agent appointed by the owner. The problem arises when the agent may act in a way that is against the interests of the owner.

The problem may occur when the owner delegates direct control over that asset or the firm to the representative or the agent.

In 1984, the Walt Disney Company brought in Michael Eisner, a Paramount executive as CEO. The firm's board of directors agreed to pay Eisner a salary of $750,000, plus a $750,000 bonus for signing on, plus an annual bonus equal to 2 percent of the dollar amount by which the firm's net income exceeded the 9 percent return on shareholder\'s equity. In addition, he received options on 2 million shares of Disney stock, which meant that he could purchase them from the firm at any time during the five year life of the contract for only $14 per share.

At the end of 1984, shareholders\' equity was about$1.15 billion. How much would Eisner\'s 1985 bonus have been if Disney's net income that year were $100 million? If it were $200 million? In 1997, the price of Disney stock rose to about $20per share. What was the capital gain value of Eisner's stock options? Eisner\'s bonus was $2.6million in 1996 and $6 million in 1987. Including the stock options he exercised, his compensation in 1988 was about $41 million, a record at that time for any U.S. executive.

Surprisingly there was not much of an opposition from the board of directors. The reason was simple, the CEO more than fulfilled the required performance. But, the potential of conflict arrives when for whatever reason the performance goes down, shouldn't his compensation be truncated accordingly.

These are potentials for principal - agent problem for Disney.