Introduction to Financial Management and Agency Theory

What is financial management?

• Financial management is the process of planning, organizing, directing, and controlling the financial activities of an organization.

• Financial management is the art of painting landscapes.

• Financial management involves skydiving as a hobby.

• Financial management is the process of cooking meals for a family.

Explain the importance of financial management in an organization.

• Financial management has no impact on decision-making

• Financial management is only important for large organizations

• Financial management is important for planning, organizing, directing, and controlling financial activities, ensuring efficient resource utilization, proper fund allocation, accurate financial reporting, aiding decision-making, risk management, and achieving financial goals.

• Financial management does not involve risk management

Define agency theory in finance.

• Agency theory suggests that shareholders have no influence over managerial decisions.

• Agency theory primarily deals with the interaction between government agencies and private companies.

• Agency theory in finance explains the relationship between principals (shareholders) and agents (managers) in a company, highlighting potential conflicts of interest and the need for alignment mechanisms.

• Agency theory focuses on the relationship between customers and businesses.

What are the key assumptions of agency theory?

• Principal self-interest

• Convergent interests between principal and agent

• Perfect information symmetry

• Divergent interests between principal and agent, agent self-interest, information asymmetries

How does agency theory help in understanding the relationship between principals and agents?

• Agency theory only benefits the agents, not the principals.

• Agency theory provides a framework to analyze conflicts of interest and align the goals of principals and agents.

• Agency theory focuses on promoting conflicts of interest between principals and agents.

• Agency theory has no impact on aligning the goals of principals and agents.

Discuss the principal-agent problem in the context of agency theory.

• The principal-agent problem in the context of agency theory refers to the conflict of interest that exists between the two parties due to information asymmetry and the agent's self-interest potentially diverging from the principal's goals.

• Information symmetry between the principal and agent helps in resolving the principal-agent problem.

• The principal-agent problem arises due to perfect alignment of interests between the principal and the agent.

• The principal-agent problem is not relevant in agency theory.

What are the mechanisms used to mitigate agency problems?

• Employee empowerment

• Increased bureaucracy

• Customer satisfaction surveys

• Proper corporate governance structures, aligning incentives, monitoring and auditing, board independence, shareholder activism, regulatory oversight

Explain the concept of moral hazard in agency theory.

• Moral hazard is the risk of market competition in agency theory

• Moral hazard is the risk of financial loss in agency theory

• Moral hazard is the risk of physical harm in agency theory

• Moral hazard in agency theory is the risk that an agent may act in their own self-interest rather than the best interest of the principal due to information asymmetry.

How do incentive alignment and monitoring help in reducing agency costs?

• Incentive alignment ensures agent's interests align with principal's, while monitoring oversees agent's actions to reduce conflicts of interest and moral hazard.

• Incentive alignment and monitoring are not related to agency costs

• Monitoring increases agency costs

• Incentive alignment creates more conflicts of interest

Discuss the role of corporate governance in addressing agency conflicts.

• Corporate governance plays a crucial role in mitigating agency conflicts by providing oversight, aligning incentives, and promoting transparency.

• Transparency in corporate governance leads to increased agency conflicts

• Agency conflicts are resolved through employee training programs

• Corporate governance has no impact on agency conflicts