Explain several dimensions of the shareholder-principal conflict with manager-agents known as the principal-agent problem. To mitigate agency problems between senior executives and shareholders,...

Chapter 1: Exercises 2, 3, and 6
2. Explain several dimensions of the shareholder-principal conflict with manager-agents known
as the principal-agent problem. To mitigate agency problems between senior executives and
shareholders, should the compensation committee of the board devote more to executive
salary and bonus (cash compensation) or more to long-term incentives? Why? What role does
each type of pay play in motivating managers?
Several Dimensions of principal agent problem are as follows:
The Principal-agent problem is arises when an agent is supposed to act in the best interest of
the principal. In other words, whenever an individual (the principal) has another person (the
agent) perform a service on her behalf and cannot fully observe the agent's actions, a ‘principal-
agent problem’ arises. The underlying assumption is that the agent's interests may differ from
those of the principal. Such relationships arises either through obligatory contractual
elationships or informally which gets revealed sometime. This problem is basically lined to
asymmetric information with respect to the difference in the interests of the two parties.
Under this, one of the problem that manager faces is that he/she needs to keep the company in
a profitable situation as well as higher values for the shareholder’s dividends. Here, there are
high chances that the agent have hidden information which helps in determining level of their
enefits and also the benefit of the principal in which none of them could get in the absence of
the relationship. The agent has special skills in respective areas of work with which the principal
use for their interests. In this case it’s extremely hard to monitor the steps taken by the agent
to execute his/her duties since this might lower their performance as a feeling of mistrust from
the principal. Mutual consent is of great importance in this kind of relationship.
Contrary to this, the principal need not have to disclose the challenges and issues faced while
pursuing the goals. The investment itself means that the individual is taking a risk for which the
eturns are uncertain. This calls for initiating incentives to the agents to maximize the chances
of attaining these set targets.
To overcome this problem, managers should be able to maintain a balance between the
earnings distributed to shareholders and the amount to be retained for growth purposes.
Policies should be put in place which looks at both sides of concerns.
The compensation committee of the board should integrate a short term and a long term
emuneration measures to encourage the agents achieve higher targets through cash
compensation and better working environment.
This is because of the need to have greater returns in every financial year and make the
managers’ part of the companies’ success.
Additional executive salary and...