Scenario: I am really upset! Here\'s the deal…we have all heard of agency theory

Question

Scenario:
I am really upset! Here's the deal…we have all heard of agency theory or agency costs, haven't we? Well, a very large manufacturing company we will leave un-named is doing something that makes me uncomfortable and upset. They have the major share of the world market for variable widgets.
Current management has been in control of the company for over 12 years and I am thinking they are doing things that will hurt shareholders and also the earnings of the company. So here is my problem: What activities should we look for in order to determine if an entrenched management is taking actions that would harm us as shareholders? Also, how will these actions harm the stockholders? Finally what can be done to insure that we will have a greatly reduced probability of agency issues with the management? Basically, how should upper management be compensated to make sure they do the right things?

Explanation / Answer

An agency, in general terms, is the relationship between two parties, where one is a principal and the other is an agent who represents the principal in transactions with a third party. Agency relationships occur when the principals hire the agent to perform a service on the principals' behalf. Principals commonly delegate decision-making authority to the agents. Agency problems can arise because of inefficiencies and incomplete information. In finance, two important agency relationships are those between stockholders and managers, and stockholders and creditors.

The following actions of entrenched management might harm the interest of the shareholders:

1. Disposing off the asset of the company

2. Issuing equity shares in oder to dilute the shareholdings.

3. Taking wrong decision in order to reduce the overall revenue of the company.

shareholder must have a dialogue with the management to ensure that there are no difference of opinions and the risk taking capacity of the share holder and the management are in line with each other. Shareholders should discuss the concerns of the upper management , with regards to their rewards and ESOP options. their rewards and benefits could be directly linked with the earnings of the companies so that they put honest efforts to increase the earning capacit of the company in order to get better rewards thereby benefiting the shareholders.

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