Agency Problem

Agency problem is the problem or conflict between the management of the company the the owner or principal of the company. The problem or conflict comes from the different interest of management and owner. This problem will affect the performance of the company and also the financial decision of the company such as when the company want to issue the new stock or the new bond.

Besides, the companies must run the business in the best interest of all stakeholders. One of the stakeholders is the shareholder. In order to achive that goal today many companies implement the corporate governance system. The corporate governance system is used to make sure that the management of the company can run the company in the best interest of all stakeholders. Because shareholders are part of stakeholder, therefore the corporate governance system can also reduce the agency problem

1. Principal-Agent Problem.

where one party, called an agent, acts on behalf of another party, called the principal. The agent usually has more information about his or her actions or intentions than the principal does, because the principal usually cannot perfectly monitor the agent. The agent may have an incentive to act inappropriately (from the viewpoint of the principal) if the interests of the agent and the principal are not aligned.

2. Moral hazard

Moral hazard is related to information asymmetry, a situation in which one party in a transaction has more information than another. The party that is insulated from risk generally has more information about its actions and intentions than the party paying for the negative consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information.

3. Adverse Selecction

The term adverse selection was originally used in insurance. It describes a situation where an individual's demand for insurance (either the propensity to buy insurance, or the quantity purchased, or both) is positively correlated with the individual's risk of loss (e.g. higher risks buy more insurance), and the insurer is unable to allow for this correlation in the price of insurance. This may be because of private information known only to the individual (information asymmetry), or because of regulations or social norms which prevent the insurer from using certain categories of known information to set prices (e.g. the insurer may be prohibited from using information such as gender or ethnic origin or genetic test results).

Src:http://en.wikipedia.org