Agency Problem in Corporate Finance

Running head: QUESTION 0
CORPORATE FINANCE
DECEMBER 8, 2018

QUESTION 1
The agency problem is the interest conflict innate in any relation wherever it is expected by
one people to perform in the best interest of others. In corporate finance, the agency problem
usually means the interest conflict between the manager of firm and stakeholders of the
company. The manager of firm, performing as an agent for the shareholders, or principals is
expected to take decision which will maximize shareholder’s wealth even though it is in the
best interest of managers to enhance the personal wealth (ElKelish, 2018).
An agency relationship exists between the management or agent and the principal or owner or
capital providers of the firm. If the agent and principle, both are wealth maximisers then the
chances of conflict increases. The agent may take step to increase their own wealth, and this
step cannot essentially be in best interest of principal. In the case where, there is the variance
between aims management followed and then of holder, it can be inferred that the agency
problem exists. This aspect is examined in the practical section of the learning (Neal and
Warren, 2015).
There are various illustrations of the cost or action by the management that may give rise to
excessive or avoidable cost which curtails the condition of conflicts-
1. Extreme level of administration remuneration
2. Avoidance of the duty or obligation
3. The appropriation of corporate sources in the form of extreme level of perquisites
4. Ignoring investing corporate sources in possibly commercial venture to the loss of
stakeholders
5. Pursuit of sale progress at an expenditure of profit and wealth of the shareholders
6. Territory creation by manager
7. Member prosperity objects, and
8. Manipulation of dividend policy at an expenditure of stockholder wealth formation

QUESTION 2
The agency problem arises due to an issue with incentives and the presence of decision in the
achievement of task. The agent can be encouraged to perform in the way that is not
favourable for the principal, such as the situation when the agent is presented with the
incentive to perform in proper manner. One popular example of agency problem is that of
Enron. In the matter of Ponzi Schemes, agency problem may have legal concerns and
economic concerns for financiers and agents. Enron’s BOD failed to carry the supervisory
role in corporation and disallowed the inaccurate obligations, causing the corporation to
venture in prohibited activities. The management team and BOD do not have similar interest
as stakeholders. It was legal obligation of directors of Enron to secure and encourage interest
of financiers however other incentives are used for this. The absence of arrangement between
the stakeholders and boards may be the last resort of demise for Enron.
Agency problem is general in the fiduciary relationship, like between the trustee and
beneficiary; members of board and stockholders; solicitors and customers. The relationship
can be strict in a legal meaning, as is the case of the relations between advocates and the
customers. It is due to the declaration made by American Supreme Court that a lawyer should
perform in whole fairness, faithfulness, and reliability towards their customers. Certainly,
financial reporting gives useful data in other contracting relations as far as including capital
providers such as dealers, clients, auditor, regulator, and relevant tax authorities. People
detain the discussion to contracts involving capital providers for the following 3 reasons
mentioned below:
(1) These fields are main central points here (Galle and Walker, 2014).
(2) The literature on agency conflicts between managers and capital providers constitutes a
natural, interconnected subset of papers that lend themselves to a relatively cohesive
discussion, and