Question

1. The three forms of business organization.

2. The agency problem.

Answer 1

Three main type of business organisation: -

1. Sole proprietorship: -In this form the single person is the owner of the business. He funds the business on his own or through debt. There is unlimited liability and his person assets can also be used to pay the debt in case of bankruptcy.

2. Partnership: - In this form more than one person owns the business. The capital funded by these people and through loans. The net profit is distributed among the partners. The liability is unlimited in this case. Registration is not mandatory.

3. Corporation: - This form of the business is owned by the shareholders. This is incorporated as per the applicable act and has separate legal existence. Generally, it has limited liability.

Agency Problem

In corporation the owners and management are not the same. The management act as agent of the stockholders (owners). The duty of management is to act in the best interest of the owners. But the manager best interest is to maximize its own wealth.

The management may do such act which results in harm to the owners for their own benefit. Thus there arises the agency problem.

To minimize the agency problem the owners should provide incentives to the management so that the management is motivated to act in best interest. For eg , performance based incentives