Answer to Question #133529 in Finance for hina

Question #133529
Q1. discuss any 2 methods with explanation to how to resolve principal agent problem with examples
Q2. atleast explain 4 functions perform by financial manager which are not discussed commonly
1
Expert's answer
2020-09-21T06:37:16-0400

Question 1: Resolving the Principal-Agent Problem

In a principal-agent relationship, one party (the principal) appoints another party (the agent) to make decisions or act on its behalf. For example, shareholders of a company hire a chief executive officer (CEO) to run the business on their behalf. Therefore, the relationship separates the ownership (principal) of an entity and its control (agent). Conceptualized by American economists, Michael Jensen and William Meckling in 1976, the principal-agent problem occurs when there is a conflict of interest between the agent and the principal (CFI, 2020). The problem arises when the agent pursues his/her interests instead of those of the principal. Information asymmetry between the principal and the agent creates a conflict of interest. The problem results in agency costs incurred by the principal. Contract design, as well as performance, evaluation, and compensation, are appropriate methods of resolving the principal-agent problem.

Contract Design

The establishment of a contract framework helps to address the problem of information asymmetry between the agent and the principal. The contract framework helps to develop a mechanism of monitoring the agents (CFI, 2020). A contract framework can also compel the agent to act in the best interest of the principal because a breach of contract can have legal consequences. For example, a manager who discloses confidential corporate information to unauthorized parties may be criminally culpable.

Performance Evaluation and Compensation

Agent's compensation is the primary method used to align the interests of the principal and the agent. Linking payment to the performance of the agent can help to address the problem (CFI, 2020). The principal will have to spend on monitoring and evaluation, as well as provide incentives for the agent. The expenditure is necessary because it is generally impossible for the agent to ensure that the agent acts on its best interest at zero cost (Pettinger, 2017). Bonuses offered by companies depending on financial results is an example of performance-based compensation.

Question 2: Functions of a Finance Manager

A finance manager is a crucial professional in any organization. The finance manager is responsible for the finance functions of an organization and is usually part of the top management team (Dutta, 2004). Traditionally, finance managers were responsible for raising funds and preparing financial reports for the organization. However, the role of the finance manager has evolved significantly over the years to include other functions. Data analysis, investment analysis, market trend analysis, and risk management are some of the finance management roles not discussed regularly.

Data Analysis

Advanced tech development has resulted in the emergence of big data and the need for organizations to make data-driven decisions. Finance managers help teams in organizations to analyze data and make inferences informing decision-making processes.

Investment Analysis

Finance managers analyze proposed investments to determine their viability based on costs and potential returns.

Market Trend Analysis

Analyzing market trends is presumed to be a marketing role. However, finance managers analyze the markets to determine if there are potentially profitable mergers and acquisitions (M&As) opportunities.

Risk Management

Finance managers are involved in risk management. To succeed in the role, finance managers should have a sound understanding of the issues affecting their sector (Career Explorer, 2020). For example, finance managers in the healthcare sector need to understand the problems in health care finance. Similarly, finance managers in government institutions need to understand the budgeting process and government appropriations.

References

Career Explorer. (2020). What does a Financial Manager do? Retrieved from Career Explorer: https://www.careerexplorer.com/careers/financial-manager/

CFI. (2020). Principal-Agent Problem. Retrieved from Corporate Finance Institute: https://corporatefinanceinstitute.com/resources/knowledge/other/principal-agent-problem/

Dutta. (2004). Cost Accounting: Principles and Practice. London, UK: Pearson Education.

Pettinger, T. (2017, April 25). Principal-Agent Problem. Retrieved from https://www.economicshelp.org/blog/26604/economics/principal-agent-problem/#:~:text=To%20try%20and%20overcome%20the,decisions%20from%20the%20principal's%20viewpoint.%E2%80%9D



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