Question 2 (a)
The agency problem and its resolution
4 marks
- Time to write
- About 8 minutes
From an older CBCS paper
Question
Question 2 (a) · 4 marksWhat is meant by the Agency problem? How can it be resolved ? 4
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- What isThe meaning first, then the main points.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Meaning of the agency problem 1½ marks 1 min
- 2 Agency costs 1 mark 2 min
- 3 Ways of resolving it 1½ marks 4 min
Easy marks
- Meaning of the agency problem (step 1, 1½ marks): a clear definition and a line on what it covers. It opens the answer, so it takes a minute or two.
Try it first. About 8 minutes for 4 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Meaning. In a company the owners (shareholders) do not manage it themselves; they appoint managers as their agents. In theory the managers act in the shareholders' best interest, but in practice they may pursue their own goals (salary, perquisites, power, job security). This principal–agent conflict, the chance that managers place personal goals ahead of the owners', is the agency problem. A similar conflict exists between shareholders (through managers) and lenders.
Agency cost. The agency problem leads to agency costs: the extra costs borne by shareholders to monitor managers and control their behaviour. They are of four types: monitoring, bonding, opportunity and structuring costs.
How it can be resolved. By aligning the managers' interests with the shareholders':
- Performance-linked compensation: pay linked to the company's profit and to its long-term objectives.
- Employee stock options: managers gain when the share price rises, the investors' objective.
- Effective monitoring: audits, independent directors and reporting to shareholders.
- For lenders: restrictive (negative) covenants, such as a limit on further borrowing.
Where the 4 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Meaning of the agency problem | 1.5 |
| 2 | Agency costs | 1 |
| 3 | Ways of resolving it | 1.5 |
| Total | 4 |
Report a problemopens an email to admin@getkunji.com with the question ID7007-Q2aalready filled in.