Essay about Wk 1 Discussion

813 WordsNov 15, 20124 Pages
Wk1 DQs What is meant by an "agency cost" or "agency problem"? Do these interfere with shareholder wealth maximization? Why? What mechanisms minimize these costs/problems? Are executive compensation contracts effective in mitigating these costs/problems? Our textbook defines an agency problem as a “conflict between the goals of a firm’s owners and its managers” (Megginson & Smart, 2009). It then defines agency costs as dollar costs that arise because of this conflict. In the corporate structure, stockholders are the owners of the firm, and they elect a board of directors to oversee the firm and help protect their investment. The board then hires the right corporate managers to run the firm with the goal of maximizing the wealth of the…show more content…
Generally, under-performing companies are the prime targets of hostile takeovers, so it makes sense that aligning shareholder and executive goals is a major way to avoid that. One popular way of aligning these goals is through the use of elaborate, structured compensation plans for executives which directly tie an executive’s salary to the performance of the company, usually and specifically its stock price (Megginson & Smart, 2009). These compensation plans have become the norm for American corporations, and their effectiveness in solving the agency problem is debatable. On one hand, it should drive an executive to strive to maximize the shareholder wealth, and it also helps companies to attract and retain the best available managers. On the other hand, it serves to sometimes wildly inflate the compensation paid to these executives, either by corporations trying to stay competitive for the best talent, or through easily achievable goals and uncapped maximums. The structured plans, if done correctly, are an effective way to help insure the goal of wealth maximization, but they are also by definition agency costs. Hence, agency problems are inherent to our American corporate system. Works Cited: Megginson, W. L., & Smart, S. B. (2009). Introduction to Corporate Finance. Mason, OH: South-Western. Chapter 2 If you were a commercial credit analyst charged with the responsibility of making an
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