3. Agency conflicts between managers and shareholders Remember, an agency relationship can degenerate into an agency conflict when an agent acts in a manner that is not in the best interest of his or her principal. In large corporations, these conflicts most frequently involve the enrichment of the firms executives or managers (in the form of money and perquisites or power and prestige) at the expense of the companys shareholders. This usurping and reallocation of shareholder wealth is most likely to occur when shareholders do not have sufficient information about the decisions and actions being made by the firms management. Consider the following scenario and determine whether an agency conflict exists: Last week, an investigative reporter for a major metropolitan newspaper discovered that the doctors conducting clinical trials of a new cancer treatment drug are also the principal shareholders in Cancer Solutions Inc. (CSI). CSI is the company developing and attempting to market the drug. Upon being interviewed by federal authorities, the doctors acknowledged their conflict of interest but reported that they were sold the shares at a 75% discount by CSIs chief financial officer. The CFO was concerned that CSI might not be able to meet its annual performance objectives and in turn pay his anticipated multimillion-dollar bonus. Does an agency conflict exist between CSIs CFO and the companys shareholders? No; professionals, such as doctors and professional money managers, would not participate in unethical activities. No; in general, shareholders are satisfied with company officers engaging in any type of legal or illegal activity to ensure the chances of them receiving greater dividend payments. Yes; CSIs CFO engaged in unethical conduct to manipulate the firms short-term earnings and improve the likelihood of receiving his annual bonus. Yes; the shares should not have been sold at a 75% discount, which is price discrimination. Consider the following scenario and determine whether an agency conflict exists: Five years ago, Tae created a plant-care business that grew, stocked, and maintained fresh plants in office buildings throughout Houston. Over time, The Green Zone Inc. (TGZ) has grown from a proprietorship into a corporation, now reaching far beyond Houston. To finance and support this growth, TGZ issued shares that were sold to TGZ employees, Taes family members, and selected outsiders. Tae is TGZs chairman of the board of directors and CEO, but he is no longer the largest shareholder. At the latest annual meeting, two mutually exclusive proposals were placed on the ballot for discussion and vote. The first was put forth by Tae and TGZs management team, and the second was proposed by a small group of other shareholders. Both groups are adamantly opposed to the other groups proposal, even though both proposals would likely have the same effect on TGZs value and riskiness. Does an agency conflict exist between TGZs management and the small group of opposing shareholders? No; although an agency relationship exists between TGZs managementincluding Tae as TGZs chairman and CEO and the firms shareholdersthere is no agency conflict, because no expropriation or wasting of the shareholders wealth has occurred. Yes; an agency relationship exists, and an agency relationship always gives rise to agency conflicts, regardless of the actual behavior of the participants. Yes; any conflict or disagreement between the firms managers and its shareholders constitutes an agency conflict. No; Tae was the original owner of TGZ, so he would always be sensitive to the concerns of the firms current owners (shareholders) and would not engage in an agency conflict. Which of the following actions will help ease agency conflicts and better align managers objectives with the firms shareholder wealth? Pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth. Pay the manager a large base salary with a huge stock option package that matures on a single date. True or False: A small number of institutional investors are often able and motivated to bring direct shareholder pressure on a firms management in an effort to reduce potential agency conflicts. False True Suppose a new law made it more difficult to stage a hostile takeover. Which of the following groups would benefit the most? Bondholders Management Institutional investors