The concept of agency relations - Investments. Investment analysis

The concept of agency relations

In most cases, the owners of the company are not its managers. Shareholders - the owners of the company employ managers who are authorized to make managerial decisions. The interests of owners, whose goal is to maximize the well-being of shareholders, do not always coincide with the interests of the company's managers. When making managerial decisions, managers may pursue personal interests that come into conflict with the interests of owners. Agency relations are relationships that arise when one or more individuals (principals) hire other professionals or organizations (agents) to perform certain services and then delegate decision-making to that agent. In the context of financial management, the main agency relations are relations between shareholders and managers; between shareholders and creditors.

The first type of agent conflict: shareholders versus managers. Increasing the shareholders' wealth may not be the top priority of managers. For example, the main goal of managers can be to maximize the rapid growth in the scale of the company. This will allow them to guarantee their own employment in this enterprise, as changing the policy or the ownership of such a company without the consent of its management will be less likely. In addition, the management of a large company will allow them to raise their own status, influence in society and wages, and create more career opportunities for their middle and lower level subordinates. Note that the mismatch of the interests of the owners of the company and its management personnel is often associated with the analysis of alternative solutions, one of which provides a momentary profit, and the second is designed for the future.

The second type of agent conflict: shareholders against creditors. The company has obligations to creditors in terms of interest payments and repayment of principal. Lenders have the right to turn their claims on the assets of the company in the event of its bankruptcy. The cost of borrowed funds is determined by the creditors on the basis of the risk assessment associated with the provision of this loan. Suppose that shareholders, acting through company managers, decide to sell low-risk assets and invest in projects that involve high risk, or the management decides to additionally raise borrowed funds, thereby changing the capital structure. In either case, a change in the structure of the company's assets and liabilities leads to an increased risk of non-repayment of the loan. The rate of return of debt obligations is determined on the basis of a less risky structure of assets and liabilities. The increase in the risk of cash flows of the firm will lead to an increase in the required rate of return on debt obligations, which will cause a drop in the market value of the outstanding debt. Consequently, in the cases under consideration, the shareholders are trying to obtain benefits at the expense of creditors. In the event that risky projects turn out to be successful, shareholders will benefit all the way, since capital was attracted at a fixed rate. In the event that projects fail and the company can not meet its obligations, then losses will be incurred not only by the owners, but also by creditors.

There are also more fractional classifications of conflicting subgroups, each of which gives priority to their group interests.

To prevent both agency conflicts and moral hazard, shareholders must bear agency costs that include all the costs necessary to encourage managers to primarily care about increasing the company's market value, rather than about their own well-being. The existence of agency costs is an objective factor, and their magnitude should be taken into account when making financial decisions.

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