Question

Describe the agency problem in a global setting for a multinational firm. Give an example. What would you recommend to fix this problem?

Answer 1

The agency problem in a global setting for a multinational firm can arise when the managers are not making decisions that are in the best interests of the shareholders. Distributing the profits of the company amongst the shareholders is in the best interest of them. The managers wish to retain profits for their own benefit.

For example; the managers choose projects that involve high risks so that if the project succeeds they an share the maximum profits as the risk of the project is borne by someone else.

This problem can be avoided when the compensation of the managers is tied with the stock price . As the stock prices will rise, the compensation of the managers will also rise and the shareholders will also benefit as a result of which. Creating incentives for the mangers to profit out of the increased share price can eliminate the principal agent problems. As well as giving out cash bonus to the mangers on the achievement of certain targets is also helpful in eliminating this problem.

In case the project fails, the managers income will also, hence they will be more motivated to think form the perspective of the company and it's shareholders.