Corporations and the Principal-Agent ProblemThe way in which a corporation is structured and the effect thatstructure has on the corporation's behavior is known as corporategovernance.While the board of directors and top management are, in theoryrepresenting the interests of the firm owners, they may sometimespursue their own agendas..Example:Managers may procure forthemselves veryhighsalaries,orperks suchas corporateprivatejets.The conflict between the interests of shareholders and the interests oftopmanagementisaprincipal-agentproblemPrincipal-agent problem: A problem caused by an agent pursuinghis own interests rather than the interests of the principal who hiredhim.2015PearsonEducation,Inc.11
© 2015 Pearson Education, Inc. 11 Corporations and the Principal-Agent Problem The way in which a corporation is structured and the effect that structure has on the corporation’s behavior is known as corporate governance. While the board of directors and top management are, in theory, representing the interests of the firm owners, they may sometimes pursue their own agendas. • Example: Managers may procure for themselves very high salaries, or perks such as corporate private jets. The conflict between the interests of shareholders and the interests of top management is a principal-agent problem. Principal-agent problem: A problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him
Canthe Principal-AgentProblem Be Resolved?The principal-agent problem derives from economic incentives beingimproperly aligned.A remedy for theproblem must be based on aligning the interestsThis is why many top managers are paid a large part of the salary instock or stock options: their salarybecomes tiedto the performanceof the firm.However sincetheCEO owns only afraction of thefirm,incentivescan never be 100% aligned.12@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 12 Can the Principal-Agent Problem Be Resolved? The principal-agent problem derives from economic incentives being improperly aligned. A remedy for the problem must be based on aligning the interests. This is why many top managers are paid a large part of the salary in stock or stock options: their salary becomes tied to the performance of the firm. However since the CEO owns only a fraction of the firm, incentives can never be 100% aligned
HowFirmsRaiseFunds6.3LEARNINGOBJECTIVEExplainhowfirmsraisethefundstheyneedtooperateandexpand13@2015PearsonEducation,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 13 How Firms Raise Funds 6.3 Explain how firms raise the funds they need to operate and expand
RaisingFundsas a Small BusinessOwnerSmallbusiness ownershave threeprincipal methods ofraisingfundsRetainedearnings. Profits reinvested in the firm, instead of paid to firm ownersRecruitadditional owners. Such an arrangement would increase the firm's financial capital.Borrow: From financial institutions,orfromfriends or family@2015PearsonEducation,Inc.14
© 2015 Pearson Education, Inc. 14 Raising Funds as a Small Business Owner Small business owners have three principal methods of raising funds: Retained earnings • Profits reinvested in the firm, instead of paid to firm owners. Recruit additional owners • Such an arrangement would increase the firm’s financial capital. Borrow • From financial institutions, or from friends or family
Raising Funds as Your Firm Grows: Indirect FinanceAs firms get larger, the need to obtain externalfunds tends to grow.The economy's financial system facilitates the transfer of funds fromsaverstoborrowers.Firms can borrow money from banks. As such, the banks are actingas financial intermediaries, permitting indirect finance of the firm bytheirsavers.Indirect finance: Aflow offunds from savers to borrowers throughfinancial intermediaries such as banks.Intermediariesraisefundsfrom savers to lend to firms (and other borrowers).15@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 15 Raising Funds as Your Firm Grows: Indirect Finance As firms get larger, the need to obtain external funds tends to grow. The economy’s financial system facilitates the transfer of funds from savers to borrowers. Firms can borrow money from banks. As such, the banks are acting as financial intermediaries, permitting indirect finance of the firm by their savers. Indirect finance: A flow of funds from savers to borrowers through financial intermediaries such as banks. Intermediaries raise funds from savers to lend to firms (and other borrowers)