What is the possible agency conflict between inside owner/managers and outside shareholders?

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The "agency view" of corporations argues that the decisions rights (or control) of a corporation should be entrusted to a manager, so that the manager can act in the interest of shareholders . Partly as a result of this, mechanisms of corporate governance include a system of controls that are intended to align the incentives of managers with those of shareholders.

These two businessmen could represent a manager and shareholder discussing the operation of the business.

The term "agency costs" refers to instances when an agent's behavior has deviated from a principal's interest. In this case, the principal would be the shareholder. These types of costs mainly arise because of contracting costs, or because individual managers might only possess partial control of corporation behavior. They also arise when managers have personal objectives that are different from the goal of maximizing shareholder profit.

Typically, the CEO and other top executives are responsible for making decisions about high-level policy and strategy. Shareholders, on the other hand, are individuals or institutions that legally own shares of stock in a corporation. Typically, these people have the right to sell those shares, to vote on directors nominated by various boards, and many other privileges. This being said, shareholders usually concede most of their control rights to managers.

While attempting to benefit shareholders, managers often encounter conflicts of interest. For example, a manager might engage in self-dealing, entering into transactions that benefit themselves over shareholders. Managers might also purchase other companies to expand individual power, or spend money on wasteful pet projects, instead of working to maximize the value of corporation stock. Venturing onto fraud, they may even manipulate financial figures to optimize bonuses and stock-price-related benefits.

The chief goal of current corporate governance is to eliminate instances when shareholders have conflicts of interest with one another. Another important goal is to evaluate whether a corporate governance system hampers or improves the efficiency of an organization. Research of this type is particularly focused on how corporate governance impacts the welfare of shareholders. After the high-profile collapse of a number of large corporations in the past two decades, several of which involved accounting fraud, there has been a renewed public interest in how modern corporations practice governance, particularly regarding accounting.

Advocates of governance typically encourage corporations to respect shareholder rights, and to help shareholders learn how and where to exercise those rights. Disclosure and transparency are intertwined with these goals.

According to Jerzemowska, M., (2006), there is an agent relationship when a person or a group of people, who are the principals, employ a third party as an agent to perform services or tasks on their behalf. The principals delegate their decision making powers to the agents who represent the principals. There are two main types of agency relationships that exist in a firm, namely, between shareholders and mangers, and between shareholders and creditors. Shareholders are the owners of the business. Very often, they do not manage the firm as they lack the necessary expertise. Subsequently, they appoint managers to manage the firm on their behalf. Hence, in this situation the shareholders are the principals and the managers are the agents.

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& Brigham, E. F., 2005, p21). Agency conflicts between shareholders, managers and shareholders are very common.

There are various causes of conflicts between shareholders and management. Firstly, conflicts arise between management and shareholders because managers and shareholders have different aims. The objective of shareholders is to maximise their wealth, which are high dividends and high share price. However, managers do not always perform to maximise shareholders’ wealth since they will enjoy very little of that wealth. Rather, they want to maximize their salary/income, fringe benefits and job security (Jerzemowska, M., 2006). Secondly, managers favour lower risk projects and lower debts as high risk and debts increase the risk of bankruptcy and losses (Jerzemowska, M., 2006). On the other hand shareholders prefer risky projects that involve high cash-inflows and high returns and they encourage managers to finance the project by borrowing additional debts. This leads to agency problems between principals and agents. Such agency problems occur in big companies with

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There are various sources of conflicts between shareholders and creditors. According to Gweyi, M. O. (2013), high dividend pay-out is a major source of conflict between them. Shareholders always try to maximize their wealth by asking for high dividend. While the dividend of shareholders increases, interest paid to creditors remains the same. Subsequently, high dividend increases the market value of shares but decreases the market value of bonds. Hence, shareholder wealth maximization causes a decrease in creditors’ wealth. Secondly, conflicts arise through the choice of projects (Jerzemowska, M., 2006). Shareholders try to cause the company to implement risky projects with high returns prospects. However, creditors prefer low risks project/investment whereby the probability of success and loan repayment are higher. If the risky project is successful, shareholders will benefit from higher dividends as the business performance improves while creditors do not get to share the profits. They only receive a fixed interest. However, if the project is unsuccessful, creditors will have to share the losses. Additionally, conflicts arise as shareholders encourage the management to borrow more to finance the projects/investment and pay dividends (Jerzemowska, M.,

Conflicts between a company's management and its shareholders are usually referred to as agency costs and are borne by shareholders. Activist shareholders and increased corporate governance increasingly deal with agency-related conflicts, but these conflicts can be especially intense for shareholders of smaller, closely-held companies. Smaller companies can be subject to less-rigorous audits – depending on relationships with banks, customers and suppliers – and minority shareholders in closely-held companies are usually resistant to the only source of recourse, litigation, which can be expensive and risky.

Your management team may be more willing to take on higher levels of risk, – operating, financial or investing – while your shareholders desire maximized returns in the form of capital gains and dividends. Shareholders are generally risk-averse, which is viewed as prudent and conservative. If your management team receives a large portion of its compensation in annual salaries and stock options, managers have less to lose because salaries are constant, and stock option values rise in response to increased volatility, a form of risk.

Your shareholders desire minimized taxes, as opposed to maximization of shareholder wealth. Management teams sometimes exploit this by setting salaries in excess of industry norms, presumably because compensation expenses are tax deductible and lower taxable income.

It can be difficult to balance the return requirements of your shareholders with different long-term goals and tax situations. Your business could also form a plan that comes at the expense of shareholder returns. Common examples fueling these decisions include concern about leaving a legacy, engaging in “empire building," which involves acquiring companies at a fast pace, even if it involves taking on too much debt, or sacrificing profitability.

Management teams sometimes alter capital structures – the mix of debt and equity financing employed – in ways that preserve a level of control rather than a mix that maximizes wealth for your shareholders. Another example is poison-pill amendments adopted by boards of directors in support of a management team that purposely causes the company’s shares to lose substantial value in the event of a hostile takeover, offering high returns to shareholders at the expense of your company's leaders.

There may be a constant tug-of-war between your and your investors over the company’s capital. Shareholders often view excess cash on a company’s balance sheet and agitate for its return to shareholders in the form of cash dividends or the repurchase of shares, which boosts stock values. However, you may be very hesitant to do so, sometimes rightly so. You should not repurchase shares simply to appease shareholders, but only when the company’s shares are undervalued.

Also, you may want to raise capital to invest in new projects while shareholders view this as a threat. Issuing new shares can dilute existing shareholders’ stakes, and issuing debt can increase leverage risk and, therefore, the risk associated with the company’s stock. Shareholders should always read management reports on financing closely and examine the statement of cash flows to understand the methods of financing the business is using.