Question

i) explain the term "agency relationships" and discuss the conflicts that might exist in the relationship between
a) shareholders and managers
b) shareholders and creditors.

ii) what steps mY be taken to overcome these conflicts.
support with references

Answer 1

Agency Relationship

An agency relationship is a relationship of trust in which an agency's agent may act on its behalf by an individual (called the principal). The agent is supervised by the principal and must adhere to his orders.

A principal is liable for contractual arrangements entered into by the principal with third parties if the agent had express, implied or apparent authority to enter into those agreements.

Conflicts in Agency Relationship

Conflicts in actual authority - exists when the agent takes an action on behalf of the principal and he reasonably believes that the principal wants this action taken.

Conflicts in apparent authority - exists when the agent takes actions for the principal with a third party that the third party reasonably believes the agent has the authority to take

Shareholders Vs Managers

Conflicts between the management of a corporation and its shareholding is generally regarded as expense of business and borne by shareholders.

Conflicts in Returns for Shareholders

In comparison to maximising shareholder capital, shareholders want to see reduced taxes. Management teams often use this to place wages beyond market levels, possibly since expenditures on indemnification are tax deductible and decreased profits taxable.

Conflicts in Control of Debt and Equity

Management teams sometimes alter capital structures – the mix of debt and equity financing employed – in ways that preserve a level of control rather than a mix that maximizes wealth for your shareholders.

Governance advocates usually urge companies to value shareholder rights and to help shareholders learn how and where they can exercise them. These goals are related to divulgation and accountability.

Shareholders vs Creditors

The shareholders and creditors have different rights and returns, leading to potential conflicts of interest..

Conflicts in interest

Shareholders are entities or organisations who have a legal interest in the company, while bondholders are the creditors of the company. Both parties have different interactions with the business, along with different privileges and financial returns.

Conflicts in incentives and residual ownership

Stockholders have a riskier incentive than bondholders to execute programmes. Other conflicts of interest may be created by the fact that bonds also have a fixed period or maturity to redeem the bond, while stocks are forever outstanding but can also be sold at any point.

Conflicts in implied terms of legal contract

Bondholders may put contracts in place prohibiting management from taking on very risky projects or may raise the interest rate demanded, increasing the cost of capital for the company. Conversely, shareholder preferences–for example for riskier growth strategies –can adversely impact bondholders.

2 conflicts between the two parties can be resolved by adopting the suitable conflict resolution strategies as has been shown