CFA Practice Question

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CFA Practice Question

Which of the following statements is false with respect to the types of principal-agent problems?
A. Managers, who hold an excessive position in the shares of their company relative to their individual portfolios, may be induced to avoid even moderate-risk projects in an effort to safeguard their capital investment.
B. The principal-agent problem is largely between shareholders and managers. There exists no such conflict between shareholders and directors.
C. Managers, who hold stock options as opposed to shares, may be induced to take on high-risk projects.
Explanation: A principal-agent conflict may arise between shareholders and directors if the directors side with the management point of view at the expense of shareholders' interests. This conflict may especially arise if the directors are not entirely independent (i.e., they hold personal or business relations with the firm or its managers).

User Contributed Comments 3

User Comment
ThePessimist Is A false as well? The principal-agent problem arises with managers with small holdings; when a manager has a large holding, they'll be more aligned with shareholders.
ostrich A is correct. If their portfolio is abnormally high in company stock, they may be more conservative than an outside investor who holds the company as part of a balanced portfolio.
LoCo83 @ThePessimist - I would suspect that excessive share positions may induce managers to take less risky projects (with lower returns) which may not be an appropriate deployment of capital for the firm and, subsequently, the balance of shareholders. Someone please correct me if I'm on the wrong track.
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