Agency Relationship and Corporate Governance
An agency connection is what? Would any agency conflicts exist when you start your business, assuming you are the only employee and your money is the only investment? Describe your response.
A legal arrangement between two parties is known as an agency relationship. An agency relationship is created when a principal and an agent who works for that principal are involved. The principal delegated the power to the agent, who acts on the principal’s behalf. Depending on the type of employment, the authority may be to make decisions, deal with third parties, or do other things.
If you have started a business and are the only employee, it signifies that you are running everything and have used all of the funds. This situation has no delegation of power, and the principal needs a representative working on their behalf. There won’t be any agency conflict as a result. Agency conflicts typically arise when multiple people work toward the same common goal.
Would agency issues arise if you grew and employed more staff members to assist you?
Yes, it will undoubtedly result in issues with agencies. The principal will have to delegate tasks and duties to its agents to hire more staff and expand the business operations. The agent will also be given a few powers to finish the task. The principal and the agent will develop a relationship as a result. Everything now depends on the agent’s performance. The agency problem will arise if the agent cannot meet the principal’s expectations for performance.
Let’s say you sell some stock to outside investors to raise money for expansion. What kind of agency conflict can arise if you keep holding enough stock to control the business?
Agency issues will arise if more money is raised to grow the company’s operations by selling stock to other investors. When you sell stocks, you effectively give someone else a portion of your ownership. The conflict between managers and stockholders will occur as an agency conflict in such a situation, and the shareholders will be responsible for paying any associated costs. Conflicts of this nature arise because managers’ and shareholders’ interests disagree. The shareholders have a different perspective and favor taking less risk in business operations. Still, the managers are more ambitious and willing to take greater chances to maximize sales and profits.
Let’s say your business obtains funding from external lenders. What kinds of agency expenses could there be? How many lenders reduce the costs of the agencies?
In addition to increasing interest costs, borrowing money from external lenders increases agency costs. There won’t be any issues if business operations go smoothly. At the same time, the lender’s interest rate is fixed and does not change; borrowing money results in more business activities that increase the company’s profitability and directly benefit shareholders. Contrarily, if the company fails owing to significant losses, the shareholder risks losing money. In such circumstances, the agency issue manifests and leads to agency costs. These are the expenses that mostly represent lost opportunities. The lender lost an opportunity to make money because he could have done better by financing the less desirable option.
If your business succeeds, you can cash out most of your shares and hand the reins to an elected board of directors. You do not own a controlling interest or any other stockholders (this is the case at most publicly traded corporations). Name six managerial practices that might be detrimental to a company’s worth.
The managers influence several companies that are publicly traded. There is no corporation owner; the shareholders pick managers to handle its business operations. It gives rise to a significant degree of managerial leverage. They start acting haughtily and place less focus than necessary on the efficient operation of the company. It hurts the company’s business performance and causes large losses. Following is a discussion of some managerial actions that can reduce a firm’s value:
- The managers can lower the dividend payout to have more money on hand for corporate growth and acquisitions.
- They do not give their all to the company’s success, and the expansion of the business is negatively impacted.
- The managers frequently receive financial compensation from the business, negatively impacting the company’s reputation.
- Additionally, they might make biased choices to benefit their friends and family the most.
- They might prevent the business from undertaking projects with higher risk and positive NPV because they want to avoid being held accountable if the project fails.
- They may also engage in initiatives with low NPV to make a point.
Corporate governance: What is it? Identify five corporate governance policies that a company controls internally.
Some rules for conducting business apply to all corporations and businesses. Corporate governance is the term used to describe the processes and guidelines that a corporation uses to manage and direct its business activities. It makes an effort to strike a balance between the different interests. These various stakeholders include lenders, vendors, suppliers, vendors, employees, and management. The following five internal corporate governance policies of a company are covered:
- recommending and using an ideal capital structure
- establishing rules and guidelines to stop any hostility
- reviewing and evaluating the results of the
- keeping an eye on the company’s accounting system and, if necessary, making changes
What traits of a board of directors typically promote good corporate governance?
The qualities listed below are those that the board of directors must lead for good corporate governance:
- The Chief Executive Officer is not the same as the Chairman of the Board.
- Most of the board members are women.
- The board has a reasonable number of members.
- Board members receive enough compensation.
Give three corporate charter clauses that have an impact on takeovers. The following three provisions are covered:
- Targeted share repurchases for treasury
- regulating the members’ voting rights.
- Provisions and rights of shareholders.
Give a brief explanation of how stock options are used in compensation plans. What possible drawbacks can stock options as a source of pay has?
Stock options are one of the strategies businesses use to pay their staff.
In this system, company stock is made available to the employees. The striking price refers to the price at which these stocks are initially issued. The stock options have a deadline attached as well. The stock options also facilitate high commitment among the employees and foster their long-term relationship with the company. Here are a few possible issues with stock options:
- It may prompt the managers to prepare financial statements that involve manipulation or window dressing to increase the stock price.
- The managers who receive stock options will receive substantial remuneration regardless of the company’s business’s dismal performance.
Block ownership – what is it? Does it have an impact on corporate governance?
Block ownership is the type of ownership that results when an outsider owns a sizable portion of the company’s total shares. In such circumstances, the block owner takes over the management of the business. The effect of block ownership on corporate governance is that it enables the block owner to use his voting rights to influence decisions in a way that suits his preferences. Block ownership is beneficial because it enables strong governance. After all, block owners regularly check on managers’ performance and actively participate in various corporate issues.
Give a brief explanation of how legal and regulatory frameworks impact corporate governance.
Compliance with governing bodies and legal frameworks is one element that impacts corporate governance. From the investor’s perspective, these compliances are crucial since they shield them from being taken advantage of by the majority shareholders or block owners. Additionally, they make it easier for businesses to raise equity whenever needed and to have quick access to the financial markets.
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The main goal of financial management is to maximize intrinsic stock value for the benefit of society. In this sphere, special companies minimize costs through innovation in the production process, create value for the customer by providing quality services and products, and creating value for employees through training and development and foster an environment that allows employees to utilize their skills and talents.
Suppose you decide 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 go nationwide. At some point, hopefully, sooner rather than later, you plan to go public with an IPO, then 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.
Assignment: Write a short answer to these questions using the above case.
- 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? Explain your answer.
- If you expanded and hired additional people to help you, might that give rise to agency problems?
- Explain why “maximation of shareholders’ wealth” is the appropriate goal of the firm.
- What items of good corporate governance serve to mitigate the tension between owners and managers?
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