EC260 Lecture Notes - Lecture 10: Call Option, Risk Premium, Product Liability
Document Summary
Lesson 3. 2: principal agent issues and managerial compensation: principal agent issues. Principal-agent issues: arise when managers (agents) make decisions that affect the wealth of shareholders (principals) and the interests of the principal and agent diverge. Shareholders rely on effort of managers to run firm but they don"t know the degree of effort the managers are exerting on their behalf since they can"t monitor it. Managers gain utility from leisure time, there"s conflict between how much time and effort they spend working on shareholder"s behalf and how much time they spend on personal pursuits. Mitigate conflict by linking agent"s compensation to performance of firm. If interests of principal and agent can be better aligned, then no longer necessary for principal to monitor agent"s efforts since what"s good for agent is good for principal. Principal-agent problem can also arise in relationship between shareholders and creditors, and firms and consumers when it comes to product safety: the diverging paths of owners and managers.
