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IAI Actuarial Core Principles · Business Finance · Ethical responsibilities of owners and managers

In a listed company with widely dispersed shareholders, professional managers run the business day to day. Which description best captures the core agency problem between shareholders and managers?

The agency problem is that managers, who control the company, may pursue personal goals like pay, status or security rather than maximising shareholder wealth. It stems from the separation of ownership and control and from managers' information advantage over dispersed shareholders.

  1. AManagers may pursue their own interests, such as pay, status or job security, at the expense of shareholder wealthCorrect
  2. BShareholders may refuse to supply further equity capital when the company needs it
  3. CManagers always hold more shares than the shareholders they serve
  4. DLenders charge higher interest because managers are poorly qualified
  5. Shareholders cannot vote on matters affecting the company

Explanation

The agency problem arises from the separation of ownership and control. Managers (agents) have their own objectives and information advantages, so they may act in ways that do not maximise the wealth of shareholders (principals). The other options describe unrelated or incorrect situations.

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