Question

Identifying agency problems, costs, and resolutions Explain why each of the follow- ing situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be handled short of firing the individual(s) involved. a. The front desk receptionist routinely takes an extra 20 minutes of lunch time to P1-5 b. Division managers are padding cost estimates to show short-term efficiency gains c. The firm's chief executive officer has had secret talks with a competitor about the d. A branch manager lays off experienced full-time employees and staffs customer run personal errands. when the costs come in lower than the estimates. possibility of a merger in which she would become the CEO of the combined firms. service positions with part-time or temporary workers to lower employment costs and raise this year's branch profit. The manager's bonus is based on profitability

Answer 1

(a): This situation is an agency problem as the receptionist is being paid for unproductive time in the form of extra lunch time that she takes. The problem might be dealt with by the company installing a time clock that has to be punched by the receptionist whenever she leaves and then resumes work. This will make her aware of the need to return on time.

(b): This situation is an agency problem due to opportunity costs getting involved here. Money that has been budgeted to cover the project proposal is not available to fund other projects that may lead to incremental value creation. To reduce the agency cost the reward system should be based on the closeness of estimates of the employees to the actual cost.

(c): This situation is an agency problem as the prospect of selling the company for less than its fair value is substantial and hence an agency cost. To reduce the agency costs the company can be opened up for purchase bids from other firms. An open bidding will ensure that fair price of the company is obtained.

(d): This situation is an agency problem as the focus of the manager is on short term profits and the decision to fire experienced full-time employees will damage the profitability of the company in the long run. The problem can be tackled by giving the manager a stock incentive plan in which the compensation of the manager will be tied to the stock price. This will force the manager to take decisions that are beneficial to the company and hence he will not think about his interests at the cost of the company anymore.