The Conflict Between Principal And Agent

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The conflict between the principal and the agent is only an effect of a wider problem known as information asymmetry. Information asymmetry occurs in transactions where one party has more or better information than the other and creates an imbalance of power in transactions. Information asymmetry can further intensify the conflict between the principal and the agent. Within a company, asymmetry of information exists between managers (agents) and shareholders (principals). Because managers operate the company on a day-to-day basis, they have access to inside information about management accounting and financial data. Managers may use the confidential information for their own benefits rather than maximize the company’s wealth towards the goal …show more content…

The conflict between shareholders and managers will incur certain costs. Jensen and Meckling (1976) refer the associated costs to this agency problem as the agency costs and present three components of agency costs, including “the monitoring expenditures by the principal”, “the bonding expenditures by the agent” and “the residual loss”, which all incline to increase as the manager’s ownership declines. The monitoring expenditures are the costs of the principals to monitor or control the managers in order to limit the abnormal actions of the agent to make sure that the agent act for the principal’s interests. The bonding costs is paid to guarantee that the agent would not take any action which can be harmful to the principal or the principal will be compensated if such actions happen. The residual loss refers to the discrepancy between the principal’s welfare and the agent’s decisions despite the use of monitoring and bonding. Such costs are inevitable results of agency problem. Similar to the agency conflict within the firm between managers and shareholders, if information asymmetry exists between the firm and outside investors, agency conflict may also

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