Recently, some branches of Donut Shop, Inc., have dropped the practice of allowing employees to accept tips. Customers who once said, “Keep the change,” now have to get used to waiting for their nickels.

Management even instituted a policy of requiring that the change be thrown out if a customer drives off without it. As a frequent customer who gets coffee and doughnuts for the office, you notice that the lines are longer and that more mistakes are being made in your order. Explain why tips could be viewed as similar to stock options and why the delays and incorrect orders could represent a case of agency cost. If tips are gone forever, how could Donut Shop reduce these agency costs?

Answer:

•             Similar to stock options which they are offered as rewards for good service

•             Stock options are used to reward managers, presumably based on their good performance-----lead to higher stock price.

•             Donut Shop, Inc., example does not represent a clear case of agency costs because it is the management itself that has instituted the “No tips” policy and the employees have responded with reduced performance. By banning tips, management has created a situation that agency cost may be provide an incentives for employees in order to resume their working performance.

•             Agency cost----costs borne by stockholders to maintain a government structure that ensure against dishonest act of management and also gives managers the financial incentive to maximize share price.

•             Stock options, which are having the rights to purchase the company share at attractive exercise price

•             Donut Shop, Inc can reduce agency cost by introducing trust, role of leadership and increase salary