Question A.
An agency relationship is a form or a relationship where one individual acts based on authority given to them to act on behalf of another. In a sole proprietorship, or assumingly a business where only one individual is the sole employee and investor, there are no agency conflicts since they are not acting on behalf of any other party in any way ( Brigham & Ehrhardt, 2016) . If they transferred their duties to other employees or other parties invested into the business as well, then there might be some agency conflict in terms of conflict of interest if they acted in a way to further their personal agenda yet they are would be expected to act on behalf of the others investors or co-employees ( Brigham & Ehrhardt, 2016) . In that case, when I begin operations and I am the only employee, there will be no agency conflicts.
Question B.
In case an employer hires additional people to help them with the work in their business such as software engineers in the software development company, that would most definitely not lead to agency problems. Notably, agency issues are brought about when there is the conflict of interest between the persons that have been assigned roles and responsibilities in a business entity with the one assigning them the roles ( Brigham & Ehrhardt, 2016) . As far as hiring others to help in the business is concerned, these mare employees are there to develop the product. Agency conflicts typically arise between three parties: stockholders, creditors, and managers. Issuing an IPO would naturally lead to giving employees first rights to buy into the IPO so they would become shareholders and have a vested interest in controlling ownership of the company, which becomes problematic in a small company. In addition, employees can become critical to the future of the company. Their focus would be the development of the software products but not really the future of the company. However, this can change and cause agency problems in case there is an agreement between the persons on the future and direction the company is expected to take, especially if it contradicts with what the owner desires as an end ( Brigham & Ehrhardt, 2016) .
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Question C.
In a scenario, where additional capital is acquired through the selling of shares to outside parties, which would bring about shareholders, various forms of agency conflicts might arise ( Reyes, 2018) . One example of an agency conflict, in this case, would be a conflict between the stakeholders and the owner of the business. In this case, the stakeholders might desire to have the organization accomplish certain goals yet the owner might use their power, vested in the majority shares, to make the final determination of what is to be done ( Brigham & Ehrhardt, 2016) . There might also be a conflict between the owner and the shareholders about the investments to make in terms of whether long-term or short term. Here, the shareholders are likely to prefer long-term investments while the owner seems set on a short-term investment ( Kraus, 2018) . There can arise a conflict between the stockholders and the creditor as well. In the latter case, the stockholders will want to influence the riskiness of the firm while this will interfere with the creditor’s plans since the creditor will be inclined towards asserting a claim on the company’s earnings stream ( Brigham & Ehrhardt, 2016) . The creditors will do so in order to ensure that the payment of principal and interest in debt is done as required. In addition, the creditors will have a claim on the company assets especially in case bankruptcy is filed. The stockholders will also have a claim on the assets and thus this might bring about a conflict between the two ( Kraus, 2018) .
Question D.
Agency costs usually refer to the conflicts between shareholders and their company's managers. A shareholder wants the manager to make decisions, which will increase the share value. Managers, instead, would prefer to expand the business and increase their salaries, which may not necessarily increase share value. Some of the agency costs that might occur include costs of debt and opportunity wealth loss. Usually, this kind of costs occurs where there is a conflict of interest between the lenders, the owner, and the shareholders. Agency cost of debt might occur if outside lenders raise funds for the company since agency of debt is a problem rising from the conflict of interest created by the separation of management from ownership in public owned company. Corporate governance mechanism such as board of directors and the insurance of debt are used in attempt to reduce this conflict of interest. To mitigate this agency cost, lenders should implement debt covenants, which will protect them from borrowing defaulting on their obligations due to financial actions detrimental to themselves or the business.
The conflict can also be brought about in a situation where there has been a separation of ownership from the management. For instance, the shareholders’ desire to have increased returns might motivate the management to engage in risky business deals. On the other hand, the shareholders will be highly inclined towards operations that are deemed as safe especially when it involves debts. In order to minimize the agency costs, it would be vital to have an incentive for the agent, which would encourage them to act in the best interest of the lenders and stakeholders ( Brigham & Ehrhardt, 2016) . In addition, taking on extra debt usually signals to stockholders that one is diversifying his/her business into other markets, which encourages more people to buy your stock. Agency costs can also come from acquiring other companies to expand individual power or spending money on pet projects
Question E.
Six potential managerial behaviors that can harm a firm’s value include:
1. Reject risky projects that might make the manager seem as if they are underperforming. Notably, some of the projects that would propel the company to better revenue streams are likely to involve a great level of risk ( Lahlou, 2019) .
2. Reject good credit that can be utilized by the business just because they do not want to get into debt.
3. Build lavish offices and live expensive lifestyles at the cost of the company.
4. Misdirect the goals and the visions of the company to their own.
5. Reject projects that seem to have a risky NPV ( Lahlou, 2019) .
6. Take on risky NPV projects with the intention of making a fortune.
Question F.
Corporate governance is the set of regulations and laws that are put in place in order to help guide on how the company or organization will be managed ( Reyes, 2018) . The specific provisions that are set under the firm’s control include:
a. Accounting control systems,
b. Compensation plans,
c. Bylaws that deter hostile takeovers,
d. The mechanisms used to discipline the board of directors,
e. Choices of the capital structure to deploy ( Reyes, 2018) .
Question G.
Various characteristics lead to the effective corporate governance offered by the board members. These include:
a. Refusing to have the CEO as the chairperson of the board of directors. This would bring about a situation where the CEO can take advantage of their positions to accomplish personal goals that are against or contrary to organizational goals ( Reyes, 2018) .
b. The size of the board matters. Since the board of directors has expenses that have to be met by the company, it is vital that the size of the board be reasonable and only includes members that are much needed in order to minimize on the expenses ( Brigham & Ehrhardt, 2016) .
c. It is also vital to have an incentive system that can be applied to the members of the board when it comes to their remuneration. This should be linked to the performance of the company. Such a situation would encourage the board members to perform their duties diligently ( Yocam, 2010) .
d. The members of the board have to be knowledgeable persons that have value to add to the board and the company at large based on their experience and networking capability. It is recommended that they be persons that can bring about business to the company ( Yocam, 2010) .
Question H.
Three provisions contained in the corporate charter that can affect takeovers are:
a. The restriction of the voting plans and rights,
b. Management of targeted share purchases,
c. Rights of the shareholders ( Lahlou, 2019) .
Question I.
Stock options are applied in compensation plans to help provide the owner of the option with the right to participate in the buying of a company’s shares ( Kraus, 2018) . Such purchases are done using specific prices. However, the option is only valid for a specific period of time after which they cannot be exercised.
Some of the problems of having stock options as a form of compensation includes the fact that the tax implications of using these options for the employees will often are very complicated ( Brigham & Ehrhardt, 2016) . In addition, it is hard to value the stock options and can result in the over-compensation of the executives just because the business/company has made some mediocre results. Finally, the compensation is dependent on the collective input of the staff, which might be unfair for some whose output is better than that of the other staff members ( Kraus, 2018) .
Question J.
Block ownership is one where a large part of a company’s shares is owned by an outsider. These shares are referred to as a block. Block ownership allows the outside to have a high level of influence on the corporate governance of an institution ( Brigham & Ehrhardt, 2016) . Thereby, the management is likely to adhere to set guidelines and regulations, which are inclined to further the agenda of the outsider.
Question K.
Legal systems and regulatory agencies enable an organization‘s corporate governance to take serious consideration of the investors’ interests as it makes it decisions ( Lahlou, 2019) . Consequently, it is likely that such an ideal organization will have better and more stable stock prices, lower costs of equity, be trusted enough to have increased access to the financial markets as compared to those companies whose corporate governance is not investor centered, and finally to have high market liquidity ( Brigham & Ehrhardt, 2016) .
References
Brigham, E. F., & Ehrhardt, M. C. (2016). Financial management: theory & Practice. 15 th Ed. Boston: Cengage Learning
Kraus, H. (2018). Executive stock options and stock appreciation rights. Employment Law Series. New York, NY: Law Journal Press
Lahlou, I. (2019). Corporate Board of Directors: Structure and Efficiency. Salmon Tower Building New York City: Springer International Publishing
Reyes, J. (2018). Reframing Corporate Governance: Company Law Beyond Law and Economics. Northampton, Massachusetts: Edward Elgar Publishing
Yocam, E. (2010). Corporate Governance: a Board Director’S Pocket Guide: Leadership, Diligence, and Wisdom. New York, NY: iUniverse
