Paying Payroll Service (PPS) recently declared bankruptcy. The price of PPS's stock has dropped from approximately $10 per share one year ago to $1 today. You can imagine that stockholders are not happy that the value of their stock has dropped so significantly. At the same time the financial position of the firm was deteriorating, PPS executives increased their salaries and perquisites substantially. Nothing they did violated any laws or was considered an unethical act. We would most likely describe this situation as _____.
A)an agency problem
B)an accounting glitch
C)an appropriate use of the tax laws
D)an appropriate action, because executive compensation should always be increased substantially each year
E)acceptable, because it is obvious that the executives were trying to maximize the value of the firm, which is what the shareholders want them to do

Question

Paying Payroll Service (PPS) recently declared bankruptcy. The price of PPS's stock has dropped from approximately $10 per share one year ago to $1 today. You can imagine that stockholders are not happy that the value of their stock has dropped so significantly. At the same time the financial position of the firm was deteriorating, PPS executives increased their salaries and perquisites substantially. Nothing they did violated any laws or was considered an unethical act. We would most likely describe this situation as _____. 
A)an agency problem
B)an accounting glitch
C)an appropriate use of the tax laws
D)an appropriate action, because executive compensation should always be increased substantially each year
E)acceptable, because it is obvious that the executives were trying to maximize the value of the firm, which is what the shareholders want them to do

Quizplus · Accepted Answer

This situation represents an agency problem, which occurs when there is a conflict of interest between the goals of the principals (in this case, the stockholders) and the agents (the executives of the company). The executives were focused on maximizing their own compensation, while the stockholders were interested in maximizing the value of their investment. This misalignment of interests resulted in a decline in the value of the stock.

Paying Payroll Service (PPS) Recently Declared Bankruptcy