Define each of the following terms IN YOUR OWN WORDS: a. Agent; principal; agency relationship b. Ag

QUESTION

Define each of the following terms IN YOUR OWN WORDS:
a. Agent; principal; agency relationship
b. Agency cost
c. Basic types of agency conflicts
d. Managerial entrenchment; nonpecuniary benefits
e. Greenmail; poison pills; restricted voting rights
f. Stock option; ESOP
a) Agent; principal; agency relationship When any person or an entity acts on behalf of another, then such person is called an Agent and another is called Principal and the arrangement between principal and agent is known as agency. For example, shareholders are the owner of company but they elect Board of Directors to act on behalf of company for its management and other operational matters. In this case Board of Directors acts as an agent of Shareholders and so there exists Principal-agent-relationship. b) Agency Cost Agency cost is an inherent cost which arises in every Principal-agent-relationship. It arises when principal and agent does not get agreed upon the same terms of actions as required. In other words, where there occurs any conflict of interest between the principal and agent then it will be called agency cost of disagreement and it results in agency problems. As for example in case of company, shareholders aim to run company in a manner to maximize their wealth, whereas board of directors may wish to run company in a manner to attain personal benefits. This situation will result in loss to company and called as agency cost. c) Basic Types of Agency Conflicts Conflict of Interest- when agent starts working on their personal interest rather than following the principals goal then there exist the conflict of interest. This situation may arise due to many reasons like uncertainty, improper flow of information etc. This conflict will results in agency costs.

Incentive Issues- Conflicts may arise when the agents incentive does not match with their expectation which may lead them to work for attaining their personal goals & demotivation. This situation will lead to loss of interest in agency. Asymmetric information- Motivational issues and asymmetric flow of information may also lead to conflict in agency arrangement. d) Managerial entrenchment; non-pecuniary benefits Managerial entrenchment is a situation where there is a conflict of interest between the managers and the shareholders of the company. In other words, the decisions made by the managers are in order to attain personal benefits and the same does not match with the concept of maximization of shareholders wealth. A non-pecuniary benefit refers to those benefits which are provided in terms of non-cash incentives. These are the perquisites provided by the company such as residential accommodation, use of motor vehicle, etc. e) Greenmail; Poison pills; restricted voting rights Greenmail or Poison pills refer to the money paid by a target company to its acquirer in order to make it stop purchasing the stocks. It is a kind of antitakeover measure where the acquirer company sells to the target company the shares at a high premium and with an assurance not to repurchase or invest in the stocks of the company till the conclusion of a certain period. f) Stock Option; ESOP Stock option refers to an opportunity, which gives the receiver the right to buy or sell a stock without placing any kind of obligation upon him. The receiver has the choice to buy or sell the options at the pre-determined price at the end of a particular period. Employee Stock Option Plan is a scheme where under the employer gives an option to the employees of the company to subscribe or hold stock. This is in order to encourage them and make them stay in the company for a long term. Under the scheme, the stocks of the company are provided at nominal or nil amounts after the expiry of a term of the employee in the company. The options till the term of maturity remain in an option fund.

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