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IAI Actuarial Core Principles · Business Finance · Key principles of finance

In a listed company the shareholders (principals) appoint managers (agents) to run the business. Which of the following best describes the agency problem that arises from this arrangement?

The agency problem is that managers, who control the firm, may act in their own interests such as pay, status or an easy life instead of maximising shareholder wealth, because ownership and control are separated and their incentives differ.

  1. AManagers may pursue their own interests, such as pay, status or a quiet life, at the expense of shareholder wealthCorrect
  2. BShareholders are legally unable to remove directors once they are appointed
  3. CManagers always hold more shares than the shareholders they serve
  4. DDebt holders control all investment decisions of the company
  5. The company cannot lawfully distribute dividends while managers hold options

Explanation

Agency problems arise because ownership and control are separated and the parties' interests differ. Managers may prefer personal benefits or lower risk rather than maximising shareholder value. The other options state things that are false or irrelevant to the agency relationship.

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