1. Agency problems – why they arise, ways to reduce them (board of directors for ex.)

• Corporations are owned by shareholders that want managers to maximize their wealth.

• Agency problems arise due to the separation of ownership and management

* Managers may have conflicts of interest with shareholders (maybe they want to maximize their own wealth rather than the shareholders wealth) – This is called an Agency Problem because the managers are acting as agents for the shareholders.

Examples of agency problems:
1. Purchasing private jets for personal use
2. Overindulging in expense account dinners
3. Avoiding risky projects because they are worried about the security of their jobs
4. Manipulating accounting earnings to increase their compensation

Reducing Agency Problems

The goal is to align the interests of managers and shareholders. This can be accomplished through:

• Compensation plans tied to the performance of the firm (assuming of course that the reporting of the numbers is not fraudulent!). It is best is performance is measured by stock value or other cash flow measure.
• The Board of Directors oversees management and can fire them
-problems with the board of directors lack of independence arises here. Oftentimes the Board and top management are part of (as they call it) “the old-boy network”. They are related, or play golf together, their families know each other, they socialize together, and most likely they all make money off of each other through various business ventures. This lack of independence inhibits the Board’s monitoring power, or willingness to report/question questionable practices.

2. Goal of financial manager and problems w/ alternative goals such as profit maximization

Goal- to maximize the wealth of the owners, the stockholders. The financial manger is a caretaker of the stockholder’s money.

3. Forms