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Agency problem is the likelihood thatmanagers may place personal goalsahead of corporate goals.

A characteristic feature of corporateenterprises is the separation betweenownership and management.

Thus, with the objective of survival,management would aim at satisfyinginstead of maximizing shareholderswealth.

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The agency problem can be prevented by:

Market Forces

Agency CostsMarket Forces:

It is of two types:

Behaviour of security market participantsHostile Takeovers

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Behaviour o f secur i ty m arket partic ipants:

The participants include institutional

investors(mutual funds, insurance etc.) actively

participate in management. They use their voting

rights to replace more competent management.

Hos ti le takeovers:

It is the acquisition of the firm by another firm that isnot supported by management. The constant threat

of takeover motivate management to work for

maximising owners wealth.

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These are the costs borne by

shareholders to prevent agency problem

as to maximise owners wealth. They have to incur 4 types of costs:

Monitoring

Bonding

Opportunity

Structuring

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Moni tor ingthe activities of the management toprevent satisfying and maximising owner wealth.

It relates to the payment for audit and control

procedures to ensure that management is workingfor maximising owners wealth.

Bondingprotects the owners from theconsequences of dishonest acts bymanagement/managers.

They firm pays to obtain a fidelity bond from athird party bonding company to compensate forfinancials loses due to dishonest acts.

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It is of two types:1. Incentive Plans2. Performance Plans

Inc ent ive Plans : They tie management compensation to sare

price. The most widely used plan is stock options

which allows management to acquire sharesat special prices. Higher price will result inlarger management compensation.

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Perfo rmance Plans :

These plans compensate management on

the basis of its proven performances. Performance shares are given to

management for meeting the stated goals

Another type, cash bonusescash

payments are given for achievement of

the stated performance goals.

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Thank you...!!