Final answer:
The action that creates an agency problem is the financial manager choosing projects that maximize their personal compensation, as this might conflict with shareholder interests. Shareholders use voting systems to select company managers, and banks are called financial intermediaries because they facilitate the movement of funds between savers and borrowers. A firm choosing between borrowing and issuing stock for expansion must consider factors like control, cost, and investment returns.
Step-by-step explanation:
An agency problem occurs when the interests of the financial manager conflict with the interests of the shareholders. In the provided options, the action that creates an agency problem is D) Choosing projects that maximize the manager's compensation. This is because the manager may prioritize their personal financial gain over the best interests of the company and its shareholders, which could lead to decisions that are not in line with maximizing shareholder value.
Shareholders choose the company's managers through voting mechanisms, typically exercised during the company's annual general meetings (AGMs) where issues like appointments to the board of directors are decided. The board, representing shareholders' interests, plays a central role in selecting and evaluating the performance of the company's top management, including the CEO.
Banks are referred to as financial intermediaries because they facilitate the flow of funds from savers, who deposit money, to borrowers, who seek capital for various purposes. This intermediation helps in the allocation of financial resources more efficiently in the economy.
When contemplating a major expansion for an established small firm and deciding between borrowing or issuing stock, one must weigh factors such as control over the company, the cost of capital, and the return on investment for each option. Borrowing maintains ownership control but involves repayment obligations and interest costs, whereas issuing stock dilutes ownership but does not require repayment. The choice depends on the firm's financial situation, growth prospects, and the preferences of the existing owners.