2.agency Problem; Principal-agent

Agency Problem in Corporate Governance

Agency Theory  Suggests

that firm can be viewed as a loosely defined contract between resource providers and resource controllers.

 Occurs

when one or more individuals called principals employ one or more individuals called agents, to carry out some service and then entrust decision-making to the agents.

Principal-Agent Specific Issues I. Diversification vs. Dividends - This is a issue about how to manage free cash flows, because managers want this funds to be invested in additional product diversification while shareholders prefer this funds to be declared as dividends so long as it is backed by income.

II. Managerial Opportunism Occurs when agents chose to use funds to unrelated diversification and growth which leads to increase in compensation income of managers while decrease the dividends declared to shareholders. -

III. Power Supremacy vs. Technical Expertise - Some of the corporate investors, most

especially institutional investors, are just putting their money with expectation of dividend at a certain time. The nature of their intention made them rely only on expertise of the agents. It is a clear picture of agents doing the real things and principals waiting for the ultimate result.

IV. Trust - Shareholders have more trust than doubts to the agents and they are entrusting everything as far as operation including the charting of the corporation’s future to its directors and officers. This is another issue because the trusts given to the agents will make them comfortable and make them lose their balance. Which is also an essential component of managerial opportunism