agency problems in finance
TRANSCRIPT
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Agency Problems in Finance
Contracting & Corporate Governance
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Agency Problems
Incentives and information
– No problems if either is perfect
Two possibilities
– Owner is sole employee
– Principal/Owner hires agent
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Owner-managed
Maximize Individual Utility
– Tradeoff profits against own interests
– Discount cash flows at “personal” rates Firm risk = Personal risk
Capital constrained manager might sacrifice long
term cash flow for short term cash flow
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Firm with Outside Investors
Shareholders own the company, so prioritizetheir interests
– All shareholders like Money so, by law – Managers have a fiduciary duty to maximize
wealth of shareholders
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Goal of Maximizing
Shareholder Wealth What about other stakeholders?
Often (not always) goals overlap
„Nexus of Contracts‟
– Labor
– Customers
– Creditors
Legal and regulatory constraints
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Moral Hazard
Hidden Action
Solutions:
– Write contracts to mitigate problem
– Monitor
– Align incentives
– Don‟t delegate
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Adverse Selection
Hidden Information
Solutions: (signaling and screening)
– Guarantees/warranties
– Reputation/brand names
– Lemon laws
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Agency Problems in Corporate
Finance Capital providers
– What firm will do with capital
– Quality of firms seeking capital
Capital seekers need to consider these
concerns
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Types of Conflicts
Intra-firm conflicts
Reorganization conflicts
Stockholder/Bondholder conflicts
Stockholder/Manager conflicts
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Intra-firm Conflicts
Firms aren‟t monolithic
Divisions raise capital from HQ
– analogous to problem of firms raising capital
from external markets
Corporate socialism
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Reorganization Conflicts
Going Public
Liquidation vs. Restructuring
– Creditors
– Managers
– Stockholders
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Stockholder/Bondholder
Conflicts Increase dividends
Subordination of claims
Asset substitution
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Solutions
Direct monitoring
Bond covenants
Reputations
Contract design
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Stockholder/Manager
Conflicts Shirking
Perquisites
Entrenchment
Outright theft
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Solutions
Carrots – Compensation contracts
– Larger ownership stakes
Sticks – Pressure from inside the firm
– Pressure from outside the firm
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Role of Governance
Capitalism requires reliable information
Good governance
– Oversight
Formal & informal
– Competition Firms that minimize costs survive
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Corporate Governance
Cash rich firms with excess capacity
– No pressure to use equity capital efficiently
TakeoversChanges in Compensation
– 1980: <20% of total CEO comp. was equity based
– 1994: ~50% of total CEO comp. was equity based
Accounting Scandals – 2002: Sarbanes Oxley
No loans to management
Required auditor independence
Penalties for incorrect financial statements
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Concluding Thoughts
Agency problems arise frequently
Contracts and markets evolve to mitigate
problems
Legal system and political/regulatory system
have an important role