Agency Problems free essay sample

Similar problems can arise between ordinary and preference shareholders, and between senior and junior creditors in bankruptcy (when creditors are the effective owners of the firm). The third agency problem involves the conflict between the firm itself—including, particularly, its owners—and the other parties with whom the firm contracts, such as creditors, employees, and customers. Here the difficulty lies in assuring that the firm, as agent, does not behave opportunistically toward these various other principals—such as by expropriating creditors, exploiting workers, or misleading consumers. In each of the foregoing problems, the challenge of assuring agents’ responsiveness is greater where there are multiple principals—and especially so where they have different interests, or ‘heterogeneous preferences’ as economists say. Multiple principals will face coordination costs, which will inhibit their ability to engage in collective action. 5 These in turn will interact with agency problems in two ways. First, difficulties of coordinating between principals will lead them to delegate more of their decision-making to agents. We will write a custom essay sample on Agency Problems or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Second, the more difficult it is for principals to coordinate on a single set of goals for the agent, the more obviously difficult it is to ensure that the agent does the ‘right’ thing. 7 Coordination costs as between principals thereby exacerbate agency problems. Law can play an important role in reducing agency costs. Obvious examples are rules and procedures that enhance disclosure by agents or facilitate enforcement actions brought by principals against dishonest or negligent agents. Paradoxically, mechanisms that impose constraints on agents’ ability to exploit their principals tend to benefit agents as much as—or even more than—they benefit the principals. The reason is that a principal will be willing to offer greater compensation to an agent when the principal is assured of performance that is honest and of high quality. To take a conspicuous example in the corporate context, rules of law that protect creditors from opportunistic behavior on the part of corporations should reduce the interest rate that corporations must pay for credit, thus benefiting corporations as well as creditors. Likewise, legal constraints on the ability of controlling shareholders to expropriate minority shareholders should increase the price at which shares can be sold to noncontrolling shareholders, hence reducing the cost of outside equity capital for corporations. And rules of law that inhibit insider trading by corporate managers should increase the compensation that shareholders are willing 4 These problems become more severe the smaller the degree of ownership of the firm that is enjoyed by the controlling shareholder.