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“It is impossible to arrange the ‘perfect contract', between managers (agents) and shareholders of a business...

“It is impossible to arrange the ‘perfect contract', between managers (agents) and shareholders of a business because decisions by the managers (agents) affect their own personal interests as well as the interests of the owners. Managers will give priority to their personal interests over those of the shareholders”. With reference to the agency theory, discuss this perceived conflict of interests.

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Expert Solution

Agency theory refers to the conflict of interest that might arise in a relationship where one party is supposed to act in the best interest of the other party and the ways to resolve them.In the given scenario the management is the agent and is supposed to be acting in the best interest of the shareholders(principal). Managers of the firm have a responsibility to act in the best interest of the shareholders.The management has the ultimate responsibility of maximizing the shareholder value.The conflict in interest may arise with regard to risk associated with projects and decision making with regard to the operations of the firm that affect long term and short term profitability.The management sometimes might make decisions that will benefit the company in the long run,but will affect it's short term earnings.This might be cause of a conflict between the principal and the agent.This conflict can be resolved by making sure the management remuneration is tied up with the earnings of the firm.

jeff jeffy answered 2 years ago
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