Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above. In your own words, complete the Mini-Case on Page 562 of your textbook. Suppose you decide (as did Steve Jobs and Mark Zuckerberg) to start a company. Your product is a software platform that integrates a wide range of media devices, including laptop computers, desktop computers, digital video recorders, and cell phones. Your initial market is the student body at your university. Once you have established your company and set up procedures for operating it, you plan to expand to other colleges in the area and eventually to go nationwide. At some point, hopefully sooner rather than later, you plan to go public with an IPO and then to buy a yacht and take off for the South Pacific to indulge in your passion for underwater photography. With these issues in mind, you need to answer for yourself, and potential investors, the following questions. a. What is an agency relationship? When you first begin operations, assuming you are the only employee and only your money is invested in the business, would any agency conflicts exist? Explains our answer A legal agreement between two parties where the one party delegates their decision making authority to another party. One is the principal and the other is called the agent. The agent is a person or entity and must be authorized by the principal in order to act on the principals behalf. Assuming I’m the only employee and the only one that is invested in the business, an agency conflict would not exist. In order for there to be conflict there must be someone else appointed to make decisions on my behalf. Because if having just one employee my own objectives for the business will always be considered. b. If you expanded and hired additional people to help you, might that give rise to agency problems? If I was to expand and hire additional people to help me, there would be a rise in agency problems. I’m this instance I would be the principal and those hired would be considered the agents. . The hired help would be expected to operate in the shareholders best interest rather than Perdue their own objectives and goals. However , the only way to take control of the matter is to keep a closer eye on the hired help, and issue contracts designed to align the interest of these managers with those of the owners. c. Suppose you need additional capital to expand and you sell some stock to outside investors. If you maintain enough stock to control the company, what type of agency conflict might occur? Selling stocks to outside investors would cause for more shareholders to have opinions on the changes and outcome of the company. By remaining the majority and in control, some of the conflicts that can occur are conflicts between the shareholders and managers. Also there may be conflict between shareholders and creditors. Should the company become successful the creditors will only gain their interest on the money they lend while the shareholder sees all of the profit. d. Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs? Agency cost that may occur due to raising funds from outside lenders includes the cost of keeping a close eye on agents to modify their behavior in the event they began to act on their own behalf. The value of the company may also be reduced by the need to increase managers salaries so they do not seek to gain their own profit but instead remain acting in the best interest of the principals. Reduction in the value of the company can be mitigated by allowing dividends to be kid only to the stockholders and come up with different perks for the managers. e. Suppose your company is very successful and you cash out most of your stock and turn the company over to an elected board of directors. Neither you nor any other stockholders own a controlling interest (this is the situation at most public companies). List six potential managerial behaviors that can harm a firm’s value. 1. The time needed to help grow the company not being given. Instead time is spent on things of unimportance. 2. Managers may take acquired information from the tools and resources provided to benefit themselves instead of that of the company. 3. Managers may come off as over the top and cocky with its expertise causing the company issues due to taking more unnecessary risks. 4. On the flip side, managers may avoid and ignore taking risks and making big decisions for the success of the company. 5. Managers may withhold important information from the stockholders in effort to control the relationship. 6. Managers may see the success of the company and positive cash flow and purchase stock that can be easily traded for cash value if needed. f. What is corporate governance? List five corporate governance provisions that are internal to a firm and are under its control. Corporate governance is the system in which a company is directed and controlled. It is essential to keep focus on the objective of corporate governance. The objective is to make better decisions. Corporate governance enables the business to be more successful through better decision making. The flow of information is the key to the effectiveness of corporate governance in an organization. Internal corporate governance controls and monitors activists and then take the corrective actions to accomplish organizational goals. 1. Monitoring by the boards of directors 2. Internal control procedures and internal auditors 3. Balance of power 4. Remuneration 5. Monitoring by larger shareholders, banks, and other creditors. g. What characteristics of the board of directors usually lead to effective corporate governance? 1. Regular meetings and all in attendance 2. Equity involvement 3. Board member skills 4. Board members age 5. Past CEO’s being present 6. Independence 7. Board size and committee h. List three provisions in the corporate charter that affect takeovers 1. Targeted share repurchases 2. Shareholders rights provisions 3. Restricted voting rights plan. i. Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation? Stock options in a compensation plan gives the owners the right to buy a share of the companies stock at a specified price even if the actual stock price is higher. The problem is focusing on short term performance rather than long term because executives were allowed to sell stock after exercising their options. Another problem is that tax laws allowed management to manage earnings by increasing the use of options instead of cash wages. j. What is block ownership? How does it affect corporate governance? Block ownership is the owning of a large block of a companies shares and bonds. These owners are able to influence the company with voting rights awarded with their withholdings. They affect corporate governance by shoving inadequate incentives to maximize values; block owners sizable stakes give them incentives to bear the cost of monitoring managers; they gain then gain control of a companies management by replacing them with a new team. k. Briefly explain how regulatory agencies and legal systems affect corporate governance. These are the laws of which a company operate. Companies with strong protection for investors have better access to the financial markets. They also have a stronger corporate governance.
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