The Relationship Between the Shareholders and the Managers Is Well Represented by the Principal–agent Theory. Discuss the Mechanisms Available to Restrain the Managers from Pursuing Their Own Aims

a) The relationship between the shareholders and the managers is well represented by the principal–agent theory. Discuss the mechanisms available to restrain the managers from pursuing their own aims.

Should managers work for their own benefit or for their shareholders’ benefit! There is a problem that might arise between the managers (agents) and the shareholders (Principals) which is called Principal-Agent Problem. “The conflict of interest between the firm’s managers and its stockholders is called a principal-agent problem, or agency problem” (Titman, 2014, P. 21). Generally, if the managers don’t have share or have less share in a company, they might not work with same motive as when they have a value from the company. Furthermore, they will choose to enjoy themselves and abuse the expenses that the company will provide them with such as; Fancy Cars, Houses, Expensive Hotel rooms, First Class Flights Tickets….etc. In Addition, managers will not risk their job taking risky work opportunities that might be fruitful for the company. As a result, a problem will show to the company, it is that the manager is not working for maximizing the shareholders wealth and benefit; this is called an agency cost. To solve out this problem, a set of things must be done to stop or frighten managers from pursuing their own advantages instead of the companies’; incentivizing managers (Compensation Plans); Direct Supervision on the managers, avoiding information asymmetry between the manager’s and the owners of the company or terminating the managers.

Compensating managers when they achieve their objectives and when they increase the stockholders’ company’s value is a good motivation. “Compensation plans can be put in place that reward managers when they act to maximize shareholder wealth” (Titman, 2014, P. 21). It is a great idea to pay the managers for their performance, they will be motivated and keen to do their job in order to get an incentive, compensation plan or annual salary increase. According to Wikipedia “Incentive Structure” Workers are motivated to supply effort by the wage increase they would earn if they win a promotion.

Could monitoring managers be of benefit to the firm? “The board of directors can actively monitor the actions of managers and keep pressure on them to act in the best interests of shareholders” (Titman, 2014, P.21). Moreover, direct and continuous contact of the firms’ owners with the managers help tracking the advancement of the work in a way to get the best of the manager for the company such as: periodic meetings, quarterly work objectives review, work improvement ideas and sharing achievements through scheduled plans.

Information asymmetries between the managers and the shareholders is critical to the company! If the two sides (The principal and the Agent) have different interests and information asymmetries; like when one (the manager) knows more information than the principal, so the owners cannot be sure that the agent is doing his best for the company instead of his own interest! Especially, when the things that are beneficial for the principal are expensive the agent and when the activities done by the agent are costly to be noticed by the shareholder. Thus, the principal will start thinking that he is taken advantage of by the agent. Therefore, avoiding information asymmetry by for example; Audition, bankers and credit agencies for assessing the firms’ performance and the security analysis for evaluating the company’s situation will be of use. “The Financial markets can (and do) play a role in monitoring management by having auditors, bankers, and credit agencies monitor the firms’ performance, while security analysts provide and disseminate analysis on how well the firm is doing, thereby help shareholders monitor the firm” (Titman, 2014, P.22).

Is the fear of termination a useful option to make the managers perform well for the best of the company? In order for the managers not to lose their jobs they should keep the stock prices of the company high and increase (if possible) their value. “Firms that underperform will see their stock prices fall and may be taken over and have their management teams replaced” (Titman, 2014, P. 22).

In Conclusion, the principal-agent problem is when the managers take an advantage of the principal and act for their own benefits instead of the principal’s benefits. Therefore, to hold the manager from doing this, there some decisions to make and implement; putting incentive and salary increase plans (Compensation Plans); Direct monitoring on the agents to ensure that the managers are doing their best for the company interest; tracking the firms performance by for example: audition and situation by for instance: security analysis; and finally putting the threat of termination if the manager act for his interest and not for the company’s interest.

b) “Liquidity ensures the ability of the firm to honour its short term commitments. This means that the firm has adequate cash to pay for its bills, to make unexpected large purchases to meet its contingencies, at all times”. Discuss.

        What does liquidity mean? Liquidity is how fast the asset or the security (investment) can be sold or bought in the market with no change in the price; it is the ability of the company to fulfil its short-term liabilities. Market liquidity indicates that to what extent the market like; stock market or real estate market can maintain assets to be sold or bough for a stable price. On the other hand, another type of liquidity is the accounting liquidity which is the liquidity that gives indicators of how easy with it the person or the firm can pay their obligations with the liquid assets they have. The most liquid asset is Cash because it can be exchanged to be other assets, while other assets such as: cars, real estates are likely illiquid. If a person wants a 500$ touch phone, it can be gotten with cash. However, if that person has no cash but an old phone that has been bought for 500$, they are unlikely to find someone willing to exchange it the touch phone for their old phone. Instead, they will have to sell the old phone and use the money to buy the new touch phone. This might be fine if the person could wait some months or years to make this purchase, but it could be a problem if the person only had some days. They might have to sell the old phone at a discount offer, instead of waiting for someone who was willing to pay the full price. The old phone is therefore an illiquid asset. We should address some topics if we want to know more about liquidity, which are; Market Liquidity and Liquidity Analysis (Liquidity Ratios).