The relationship between stockholders and management is called an agent relationship. Such a relationship exists the whenever someone (principle) hires another (agent) represent his or her interest. In the agent relationship, management and stockholder might have different interests; therefore, a possibility of conflict of interest might exist. Such a conflict is called agency problem.
Hires
Self-
interest Self-
interest
Performs
For Example, a new investment plan is considered which expect to favourably impact stock price, however, It also have a relatively risk. Because the stock price will rise, the stockholder will wish to take the investment, but management might not because the investment may fail that the management jobs will be lost. But if management does not take the investment, then the stockholders lose a chance to make money. This example is called agency cost. However, if left to themselves, managers would focus on the business power or wealth. This goal could case to an overemphasis on business size or growth. Therefore, management keep organizational survival to security.
As the graph shown, there is information asymmetric between stockholder and management. Management to a transaction has more or better information than the stockholders. This creates an imbalance in power in transactions. Asymmetric information can be financial information and business information. Also a self-interested manager could divert company funds for consumption of value-reducing private benefits. Increasing the debt level (and reducing outside equity) aligned the manager with the investors by increasing the manager’s personal equity stake in the firm, hence reducing his in ...