Question

decISIUNI 15 ML LG LGO P1-5 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 run personal errands. b. Division managers are padding cost estimates to show short-term efficiency gains when the costs come in lower than the estimates. c. The firm's chief executive officer has had secret talks with a competitor about the possibility of a merger in which she would become the CEO of the combined firms d. A branch manager lays off experienced full-time employees and staffs customer 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. Problem - The front desk receptionist is being compensated for unproductive time.

Cost - The company could install a time clock that would result in either​ (1) her returning on time or​ (2) reducing the cost to the firm.

Solution - The management could bring the situation to the attention of the receptionist. The extra emphasis on meeting her duties may be all that is required.

b. Problem - One agency cost is that money budgeted to cover the project proposal is not available to fund other projects that may help to increase shareholder wealth.

Cost - One way to reduce the agency cost is to base the reward system on how close the​ employee's estimates come to the actual cost rather than having them come in below cost.

Solution - A reward system based on increasing shareholder wealth might motivate the division managers to make more accurate estimates in order to be able to take on additional profitable projects.

c. Problem - One agency cost is that the CEO may negotiate a deal with the merging competitor that is extremely beneficial to herself at the expense of selling the firm for less than its fair market value.

Cost - A good way to reduce the loss of shareholder wealth would be to open the firm up for purchase bids from other firms once the manager makes it known that the firm is willing to merge.

Solution - An open bidding process may encourage other firms to offer a price closer to the fair market value of the firm.

d. Problem - Generally​ part-time or temporary workers are not as productive as​ full-time employees. These workers have not been on the job as long to increase their work efficiency.

Cost - This manager is getting rid of good employees to increase​ short-term profits.

Solution - One approach to reducing the problem would be to give the manager performance share if certain stated goals are met. Implementing a stock incentive plan tying management compensation to share price would also encourage the manager to retain quality employees.