Discussion Assignment 1.1.1 Principal-Agent Problem
Think back to a job you’ve had. Briefly describe the goals and objectives of owners (principals or
shareholders) of the firm and the core functions of the managers (agents) of the firm. Highlight any
sources of conflicts or moral hazard within the firm. Where did the goals of the owners diverge from
the objectives of the managers? What rules, constraints, or governance structures were put in place
to mitigate these conflicts? Are there any other ideas you would suggest in mitigating the principalagent problem?
Managers working for the retail giant Toys-R-Us will now be responsible for adhering to the decisionmaking model. One of their core function is to implement decisions made at the corporate level in
support of the principal’s goals and perhaps objectives.
The CEO – David Brandon has noted a decline in the profit margin on sales which challenges his view
of risk-bearing. According to the risk-bearing theory of profit, economic profits arise in part to
compensate the owners of the firm for taking risk that is assumed during initial investment (McGuigan,
Moyer, and Harris 8). This noted decline in profit margin is directly related to the decline in equity
payments for the board members. The CEO’s responsibility is to offer potential solutions. Over several
years, the company failed to compensate at a higher rate of return based on the level of ownership.
Though the CEO earned cash compensation of $4.4 million, he was not impressed with equity
payments for board members (Salary.com 1).
To increase the profit margin and establish greater gains in equity payments, the CEO established two
important goals: (1) close underperforming stores and (2) make the remaining stores interactive (Bomey
1). At the agreement of the board, closing the underperforming stores decreases the amount of finances
spent on leases which is a huge burden on the capital budget. The second goal, making the stores
interactive, is an attempt to appeal to the young customers as well as parents. The interactive stores will
merge Babies-R-Us with Toys-R-Us, offer full life experiences, and offer party rooms in support of a
full-life experience (Bomey 1).
With these goals set, the CEO and managers must apply the sensitivity analysis because both goals will
possibly create principal-agent conflict and moral hazard. For example, in closing retail stores there will
be loss of employment. On the other hand, to make the stores more interactive there will be a need to
increase/change skillsets thus creating new positions. Each short and long-term goal will interfere with
the organizational structure, require delegation of decision making authority, challenge organizational
objectives as prescribed by corporate owners, and warrant new policies.
The most recent bankruptcy filing revealed the objectives in great detail. For instance, as a floor sales
manager, management will be required to allow employees to open toy boxes and allow the customer
to experience the toy in-store without a guarantee of purchase (Bomey 1). The non-redeployable
specific asset could increase cost (replacement value vs. liquidation value) and not support their efforts
to increase profit margins. As managers, they have decided to create a solution by having specific toy
samples. This method would be much like the perfume counter at your local department store i.e. to let
the customer try the sample before purchase (Beatty 1). If trying the sample results in a sale, it would
now be reflected in the managers performance-based payments (McGuigan, Moyer, and Harris 12).
These payments are new policies i.e. new policies that will help management deflect from conflict in a
need to open toy boxes to increase sales.
It is evident that policies, procedures, and decisions have been at the helm of management. However,
with the new goals in place, management must consult before making decisions that are contrary to
goals and objectives. In Toy-R-Us case, management must make decision that are directly related to
increasing profit margins. Therefore, the CEO will experience increased profit margins as managers
follow the goals set before the organization.
Work Cited (MLA Style)
Bomey, Nathan. “Toys R Us Post-Bankruptcy Plan is to Make Interactive Play Spaces.” USA Today 23
Mar. 2018. .
McGuigan, J. Moyer, C. and Harris, F. Managerial Economics: Applications, Strategy, and Tactics.
Boston: Cengage, 2017.
Salary.com 23 Mar. 2018. .
Beatty, Sally. “Getting shoppers to sample perfume is not an easy job.” Wall Street Journal 23 Mar.
2018. .
Purchase answer to see full
attachment
Think back to a job you’ve had. Briefly describe the goals and objectives of owners (principals or
shareholders) of the firm and the core functions of the managers (agents) of the firm. Highlight any
sources of conflicts or moral hazard within the firm. Where did the goals of the owners diverge from
the objectives of the managers? What rules, constraints, or governance structures were put in place
to mitigate these conflicts? Are there any other ideas you would suggest in mitigating the principalagent problem?
Managers working for the retail giant Toys-R-Us will now be responsible for adhering to the decisionmaking model. One of their core function is to implement decisions made at the corporate level in
support of the principal’s goals and perhaps objectives.
The CEO – David Brandon has noted a decline in the profit margin on sales which challenges his view
of risk-bearing. According to the risk-bearing theory of profit, economic profits arise in part to
compensate the owners of the firm for taking risk that is assumed during initial investment (McGuigan,
Moyer, and Harris 8). This noted decline in profit margin is directly related to the decline in equity
payments for the board members. The CEO’s responsibility is to offer potential solutions. Over several
years, the company failed to compensate at a higher rate of return based on the level of ownership.
Though the CEO earned cash compensation of $4.4 million, he was not impressed with equity
payments for board members (Salary.com 1).
To increase the profit margin and establish greater gains in equity payments, the CEO established two
important goals: (1) close underperforming stores and (2) make the remaining stores interactive (Bomey
1). At the agreement of the board, closing the underperforming stores decreases the amount of finances
spent on leases which is a huge burden on the capital budget. The second goal, making the stores
interactive, is an attempt to appeal to the young customers as well as parents. The interactive stores will
merge Babies-R-Us with Toys-R-Us, offer full life experiences, and offer party rooms in support of a
full-life experience (Bomey 1).
With these goals set, the CEO and managers must apply the sensitivity analysis because both goals will
possibly create principal-agent conflict and moral hazard. For example, in closing retail stores there will
be loss of employment. On the other hand, to make the stores more interactive there will be a need to
increase/change skillsets thus creating new positions. Each short and long-term goal will interfere with
the organizational structure, require delegation of decision making authority, challenge organizational
objectives as prescribed by corporate owners, and warrant new policies.
The most recent bankruptcy filing revealed the objectives in great detail. For instance, as a floor sales
manager, management will be required to allow employees to open toy boxes and allow the customer
to experience the toy in-store without a guarantee of purchase (Bomey 1). The non-redeployable
specific asset could increase cost (replacement value vs. liquidation value) and not support their efforts
to increase profit margins. As managers, they have decided to create a solution by having specific toy
samples. This method would be much like the perfume counter at your local department store i.e. to let
the customer try the sample before purchase (Beatty 1). If trying the sample results in a sale, it would
now be reflected in the managers performance-based payments (McGuigan, Moyer, and Harris 12).
These payments are new policies i.e. new policies that will help management deflect from conflict in a
need to open toy boxes to increase sales.
It is evident that policies, procedures, and decisions have been at the helm of management. However,
with the new goals in place, management must consult before making decisions that are contrary to
goals and objectives. In Toy-R-Us case, management must make decision that are directly related to
increasing profit margins. Therefore, the CEO will experience increased profit margins as managers
follow the goals set before the organization.
Work Cited (MLA Style)
Bomey, Nathan. “Toys R Us Post-Bankruptcy Plan is to Make Interactive Play Spaces.” USA Today 23
Mar. 2018. .
McGuigan, J. Moyer, C. and Harris, F. Managerial Economics: Applications, Strategy, and Tactics.
Boston: Cengage, 2017.
Salary.com 23 Mar. 2018. .
Beatty, Sally. “Getting shoppers to sample perfume is not an easy job.” Wall Street Journal 23 Mar.
2018. .
Purchase answer to see full
attachment
