What factors determine an agent's incentives? How important a factor is an agent's reputation? Elaborate.

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principal-agent relationship An arrangement in which an agent acts on the behalf of a principal. For example, shareholders of a company (principals) elect management (agents) to act on their behalf. THE AGENCY ISSUE We know that the duty of the financial manager is to maximize the wealth of the firm's owners. Shareholders give managers decision-making authority over the firm; thus, managers can be viewed as the agents of the firm's shareholders. Tech- nically, any manager who owns less than 100 percent of the firm is an agent act- ing on behalf of other owners. This separation of owners and managers is shown by the dashed horizontal line in Figure 1.1 on page 54, and it is representative of the classic principal-agent relationship, where the shareholders are the principals. In general, a contract is used to specify the terms of a principal-agent relation- ship. This arrangement works well when the agent makes decisions that are in the principal's best interest but doesn't work well when the interests of the principal and agent differ. In theory, most financial managers would agree with the goal of shareholder wealth maximization. In reality, however, managers are also concerned with their personal wealth, job security, and fringe benefits. Such concerns may cause principal-agent relationship An arrangement in which an agent acts on the behalf of a principal. For example, shareholders of a company (principals) elect management (agents) to act on their behalf. THE AGENCY ISSUE We know that the duty of the financial manager is to maximize the wealth of the firm's owners. Shareholders give managers decision-making authority over the firm; thus, managers can be viewed as the agents of the firm's shareholders. Tech- nically, any manager who owns less than 100 percent of the firm is an agent act- ing on behalf of other owners. This separation of owners and managers is shown by the dashed horizontal line in Figure 1.1 on page 54, and it is representative of the classic principal-agent relationship, where the shareholders are the principals. In general, a contract is used to specify the terms of a principal-agent relation- ship. This arrangement works well when the agent makes decisions that are in the principal's best interest but doesn't work well when the interests of the principal and agent differ. In theory, most financial managers would agree with the goal of shareholder wealth maximization. In reality, however, managers are also concerned with their personal wealth, job security, and fringe benefits. Such concerns may cause

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Agent incentives in the context of corporate governance are influenced by several factors and one critical factor is the alignment of managers interes... View the full answer