Overview of Agency Conflicts
Firms can face agency conflicts resulting from conflicts of interest in agency relationships. Such conflicts can arise between creditors and stockholders, inside managers and outside managers, as well as outside stockholders and hired managers. For example, hired managers can spend corporate resources on personal perks, which leads to the waste of assets and does not contribute to the company’s value. Each type of conflict can lead to a reduction in corporate value and decreased profits.
Definition of Agency Relationships
The relationships between a principal and an agent are referred to as agency relationships. A principal hires an agent to perform a service on behalf of the principal. Therefore, an agent has decision-making power, which a principal delegates.
Both a principal and an agent can be a person or an entity. There are various types of agency relationships, including creditors and stockholders, inside managers and outside managers, and outside stockholders and hired managers (Brigham & Ehrhardt, 2019). Conflicts of interest between the parties within these types of agency relationships can lead to agency conflicts.
Creditors vs. Stockholders
The conflict between creditors and stockholders can arise because creditors have a claim on a company’s revenue streams and assets in the event of bankruptcy. In contrast, stockholders hold decision-making power that can impact risks and profitability. Creditors lend money to firms based on the assessment of risks and profitability expectations. For example, when stockholders take riskier actions than have been anticipated, the rate of return on the debt increases, and the value of the outstanding debt decreases. Therefore, creditors face a potential risk of losing money, while stockholders have a limited opportunity for taking on risky decisions, which leads to agency conflict.
Inside vs. Outside Owners
The conflict between the inside owner (or manager) and the outside owner arises when the inside owner (or manager) seeks to increase personal welfare and obtain prerequisites or perks. It leads to the potential sale of the company’s stock to outsiders, thereby increasing the company’s value. However, an outside owner, in this case, will share the cost of these perks, while for an inside owner, they will remain relatively cheap. The conflict leads to a higher rate of return required for stock shares. For example, inside owners (or managers) can award themselves more benefits, which will lead to personal profits but not increase the company’s value.
Managers vs. Shareholders
Conflicts between managers and shareholders arise when managers pursue personal benefits over intrinsic corporate value. It leads to a reduced rate of return on a company’s shares and fewer profits for shareholders. For example, managers can utilize corporate resources to acquire various perks for themselves, such as lavish offices, corporate jets, and large personal staff. Therefore, a company’s resources will not enhance the value of an organization or generate sufficient profits for its shareholders.
Reference
Brigham, E. F., & Ehrhardt, M. C. (2019). Financial management: Theory & practice. Cengage Learning.