Question

. Corporate governance is a system of checks and balances that helps to mitigate agency problems with top management. Name and briefly explain any three mechanisms and their relative effectiveness at minimizing agency costs of management to shareholders.

Answer 1

The agency problem is a common issue in most agent-principal relationships. In order to reduce agency costs (which are the consequence of the described relationship) where a shareholder is the principal and the manager is an agent, three mechanisms (incentives) are named:

- stock buying option (financial incentive) - allowing managers to buy stock at a competitive price

- profit-share or output based compensation (financial incentive) - Instead of just an hourly wage, managers would get incentivized by these financial perks.

- non-financial incentives - development opportunities, car, mobile phone...