After reading the following case, please answer the followingquestions:
1. Why does agency problem arise?
2. What is the cost of agency problem?
3. How to minimize the agency problem?
CASE STUDY ON AGENCY PROBLEM ABC
Company started operations in early 1970. The company producesspecialized items for manufacturing cars. Most of the raw materialsused are imported from Brazil because the cost is low and the laboris very cheap. The CEO for ABC Company, Mr. Rodriguez, makes everyattempt to keep the cost at the lowest. From 1970 to 2000 netincome has increased at a rate of at least 25% per year. There arearound 20,000 shareholders that hold ABC Company shares.Shareholders are very happy with the company’s performance. Mr.Rodriguez always held a meeting with Board of Directors to informthem of any decision involve in the company. As such the BOD isvery happy with the company performance and Mr. Rodriguez managingstyle. Every year, the staff received cash bonus of around 2 to 3times of their salary and Mr. Rodriguez received many incentivesfrom the company including cars, houses and cash. However, at theend of 2001, the cost of raw material increases because of theattack of SARS virus in Brazil. The sales for the year were alsoreduced. By September 2001, Mr. Rodriguez held an emergency meetingwith all the staffs. It is estimated that the income for the yearwill be reduced. By January 2002, after the preparation of thefinancial statements, net income showed a decreased of around 45%from last year. Mr. Rodriguez demanded the treasures and thecontroller to do something with the figures. During the BOD meetingin April 2002, the company announced a 15%increase in the incomeand declared a dividend of around 5% higher than last year. Theshareholders reacted positively to the announcement and startedbuying more shares of the company. For the next five years, thecompany continue to decrease in income but providing a good news tothe shareholders and giving shareholders higher profit. In 2008,the BOD requested for the company to change the auditor for thecompany. After the auditing process, the new auditor revealed thatthe company is in the state of bankruptcy and there are zerobalance cash in the bank account. One month after that the companywas forced to closed down. Shareholder were surprised with theannouncement and lost all their money. The employees lost their joband many creditors couldn’t claim their money. Shareholders arecurrently suing Mr. Rodriguez and the company for their losses.
