Two Main Causes Of Agency Conflicts Between Shareholders And Management
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.
In …show more content…
& 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 …show more content…
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.,