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Perceived managerial discretion and market competition
Finance & Accounting
Pages 12 (3012 words)
Introduction The principal-agent problem arises from the conflict of interest between the principal as represented by the shareholders and the agent as represented by the officers. The shareholders represent the owners of the organization and they want to maximize the wealth of the organization by investing in high-risk projects which offer high returns.
This organizational structure optimizes the decision-making process to the benefit of both the principal and the agent. As a result the organizational performance is maximized. By analyzing the principal-agent problem, the shareholders and the officers are able to coordinate their efforts to the best advantage. The agency theory According to the agency theory, the principal-agent problem arises from conditions of incomplete or asymmetric information when one party tries to motivate another party to act on its behalf. These conditions can be observed in any employer/employee relationship. This is because the employer, the shareholders, wants the employees, the managers, to invest in those projects which offer higher returns. However the projects which offer higher returns also have higher uncertainty. Therefore the managers may not want to take the risk. As a result there is a conflict of interest which affects organizational objectives. This is the principal-agent problem which is addressed in the agency theory. In order to maximize organizational performance, the owners of the organization have to introduce incentives which will motivate the managers/employees to act in the best interests of the shareholders. ...
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