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The financial management function

The role of management

4.1 Agency theory

Agency theory is often used to describe the relationships between the various
interested parties in a firm and can help to explain the various duties and conflicts
that occur.

Agency relationships occur when one party, the principal, employs another party,
the agent, to perform a task on their behalf. In particular, directors (agents) act on
behalf of shareholders (principals).

Issues arise when the shareholders who own the company and the
directors/managers who run the company have different interests with regard to it.

4.2 Managerial reward schemes

One way to help ensure that managers take decisions that are
consistent with the objectives of shareholders is to introduce carefully
designed remuneration packages. The schemes should:

 be clearly defined, impossible to manipulate and easy to monitor

 link rewards to changes in shareholder wealth

 match managers’ time horizons to those of shareholders

 encourage managers to adopt the same attitudes to risk as
shareholders

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