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Definition

Solutions to the Agency Problem

There are several actions can be taken by principals to minimize agency problem :

The first is for the owners to pay executives a premium for their service. This premium helps executives to see their loyalty to the stockholders as the key to achieving their personal financial targets.

            A second solution to agency problem is for executives to receive back loaded compensation. This means that executives are paid a handsome premium for superior future performance. Strategic action taken in year one, which are to  have an impact in year three, become the basis for executive bonuses in year three. This lag time between action and bonus more realistically rewards executives for the consequences of their decision making, ties the executive to the company for the long term, and properly focuses strategic management activities on the future.

            Finally, creating terms of executives across different units of a corporation can help to focus performance measures on organizational rather than personal goals. Through the use of executive terms, owner interests often receive the priority that they deserve.

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