An agency issue is most apt to develop when: O A. a firm encounters a period of stagnant growth. B. a firm downsizes. O C. the control of a firm is separated from the firm’s ownership. O D. the firm’s owner is also its key manager. E. a firm is structured as a general partnership. None
An agency issue is most apt to develop when: A. a firm encounters a period of stagnant growth. B. a firm downsizes. OC. the control of a firm is separated from the firm’s ownership. D. the firm’s owner is also its key manager. OE. a firm is structured as a general partnership.
The correct answer and explanation is:
Correct Answer: C. The control of a firm is separated from the firm’s ownership.
Explanation:
An agency issue arises when there is a conflict of interest between the principals (owners/shareholders) and the agents (managers or executives) who are tasked with managing the company. This conflict is most likely to occur when the control of a firm is separated from its ownership. This separation is typical in corporations where shareholders own the company, but they do not directly manage its day-to-day operations. Instead, they appoint executives and managers to make decisions on their behalf.
The root of an agency issue lies in the differing goals of owners and managers. Shareholders generally want to maximize the long-term value of the firm, as it increases their wealth. Managers, however, may prioritize their own interests, such as higher compensation, job security, or prestige, which can lead to decisions that do not align with shareholder value maximization.
For instance, managers may engage in empire-building, expanding the company unnecessarily to increase their control and importance, even if such growth reduces shareholder value. Alternatively, they might avoid high-risk, high-reward investments to protect their jobs, despite such investments being in the best interest of the shareholders.
Mechanisms to mitigate agency issues include implementing performance-based incentives for managers, appointing a strong board of directors, or instituting active shareholder oversight. These measures align managers’ interests with those of the shareholders, ensuring decisions benefit the firm as a whole.
In contrast, options like D (when the owner is also the manager) or E (a general partnership) are less prone to agency problems, as there is little to no separation between ownership and control. Therefore, the correct and most relevant answer to the question is C.