What is a Fiduciary Legal Obligation?

Question A. 

An agency relationship is a legal fiduciary obligation that an employee owes to his employer by virtue of consenting that he will act on behalf of the employer upon the employer’s consent. The agency relationship is governed by agency law, which defines the relationship between the agent party and principal party in the relationship ( Schulze, Lubatkin & Dino, 2003 ). The agent consents to act on behalf of the principal. Employment relationships are typical agency relationships. Employees perform physical service when employers hire them. They have to possess the express authority of their employer to act on their behalf. For instance, managerial employees with the express authority of their employer are the only ones who can enter into a binding contract with other parties on behalf of their employer. 

An agency relationship is established in several ways. First, express agency happens when an agent and a principal make an express agreement that one would act on behalf of the other ( Schulze, Lubatkin & Dino, 2003 ). The agreement may be in the form of a written contract or oral consent. Secondly, implied agency happens when the conduct between any two parties make them likely to infer the existence of an agency relationship. Thirdly, the agency through ratification occurs when some person falsely purports to act as an agent of another individual (principal), but instead of the purported principal opposing the actions, he chooses to accept the action of the false agent. By law, the decision by the purported principal to accept the actions of the agent ratifies them and establishes a binding agency relationship. 

When one starts a business with his own capital money and operates as the only employee, then there is still no issue of the agency relationship. The business has no two parties, where one would act as an agent and the other as a principal ( Schulze, Lubatkin & Dino, 2003 ). This fact eliminates the possibility of any conflict over an employer-employee agency relationship because the person who is the employer is the same person who functions as an employee. 

Question B. 

When one decides to hire additional people to work as employees in the organization, then they establish a legitimate agency relationship. The employees agree to work on behalf of the employer. Through the employment relationship, the employer gives his workers the authority to perform the work of the business on behalf of the employer. Agency problems may arise when an employee acts outside the job descriptions carried in his employment contract ( Schulze, Lubatkin & Dino, 2003 ). For instance, an assembly line employee who proceeds to sign a financial document on behalf of the firm may be acting outside the agency relationship because his employer has not given him consent to perform financial transactions for the firm. 

Question C. 

In company ownership, stockholders (investors) have an agency relationship with the firm managers. When a founding shareholder who manages the firm decides to sell part of the firm’s equity to investors, he expands the opportunity for an agency conflict/problem ( Hillman & Dalziel, 2003 ). This is most likely to occur when then founding shareholder maintains a majority stock that gives him control over the company. The manager will always carry an agency cost against all other minority shareholders. Whenever the founding shareholder takes the daily managerial decisions without informing the other shareholders, the minority shareholders will feel slighted and bypassed in the decision-making process. 

They might feel that they did not consent to the action by the majority shareholder who doubles up as the manager of the firm. However, the reality is that even if all decisions for the firm were to be subjected to a vote, the majority shareholder (the manager) would always have his way because he holds a controlling stake in the firm ( Hermalin & Weisbach, 2001 ). 

Question D. 

When a company chooses to raise funds from third-party lenders, the act establishes an agency relationship between stockholders and creditors. The lenders create an agency relationship with the firm through its stockholders. They give loan money to the company if they are sure that the stockholders will be able to pay back the money with profit. They hope that the stockholders will act in good faith by doing business with the loan money and diligently repaying it with interest to the lender. They essentially handle the principal cash on behalf of the lender and repay it after the agreed period ( Schulze, Lubatkin & Dino, 2003 ). The company stockholders are allowed to make their own internal decisions on how they will use the money, as the lenders presume that the funds will be allocated prudently on their behalf to yield profitability and repay the loan amount. 

According to Schulze, Lubatkin, and Dino (2003 ), to mitigate the agency costs in the stockholder-creditor relationship, the creditors often take a preliminary assessment of the company's capital structure, its business risk, and overall financial health to determine that it makes sufficient revenue to repay the principal loan amount plus the interest. The creditors are mainly concerned with the potential cash flow of the organization because this information helps them to avoid getting into bad debts that will be written off eventually to create a loss for the lender. 

Question E. 

Start-up companies may grow to become increasingly profitable to a point where the founding shareholder decides to sell most of his equity in the firm. At this point, according to Hermalin and Weisbach (2001 ), the company may start operating with a board of directors that is elected by the stockholders in a situation where no single person holds controlling stock in the firm. This is the typical operational scenario for public companies. Under this modus operandi, several negative managerial behaviors in the firm may undermine its value to stakeholders and stockholders in the long term. 

First, the value of the firm in the stock market may reduce if its internal managers disregard merit-based performance appraisal in favor of nepotism and favoritism. Persistent rewarding of mediocre employees at the expense of competent ones undermines the concept of merit, diligent hard work, performance, and productivity. 

Secondly, when the management perpetuates a totalitarian culture that dissuades employees from speaking up when things go wrong, the company is likely to descend along a steep decline in the long term. In such situations, employees will show the unwillingness to engage the top management when necessary out of fear for victimization. 

Thirdly, the value of the firm is likely to dwindle when the management gives priority to personal agenda instead of steady corporate growth. 

Fourthly, the management of a firm may choose to consolidate more market power by buying controlling stakes in several rival firms within the industry. It would have achieved the goal of controlling the industry at the cost of cutting back on the shareholder dividends paid to the stockholders. Such decisions undermine the value of the firm to the stockholders in the short term due to an agency conflict problem. 

Fifthly, the management may harm a firm’s value if they perpetually avoid tough decisions just because they want to appeal loyal to other associates in the company. 

Sixthly, the management may harm a firm if they suspend the payment of dividends to shareholders and instead choose to invest the funds in marketable securities. 

Seventhly, it is wrong for the management to try managing and controlling the information it releases to the public concerning its earnings and performance for public relations purposes. Such actions amount to deliberate attempts to mislead the public, only for the real information to surface later after the successfully controlled media releases have lost meaning. 

Question F. 

Corporate governance can be defined as the set of processes and rules that control and direct the operations of a company. The rules create an intricate balance between the diverse interests of customers, government, shareholders, suppliers, management and financiers of the company ( Hermalin & Weisbach, 2001 ). Further, according to Hermalin and Weisbach (2001 ), some corporate governance provisions that are used to achieve internal control in a firm include: 

Policies for discipline and monitoring of managers who work under the board of directors 

Policies for achieving accounting control, which involves internal bookkeeping and regular auditing 

Employee compensation plans that define the remuneration and benefits packages for employees 

Capital allocation structures within the corporation 

Charter provisions that define conditions where hostile takeovers may be executed 

Question G. 

Board of Directors needs to maintain a high level of independence to be able to govern corporations effectively ( Coles & Hesterly, 2000 ). The agency theory posits that every actor in the relationship retains some level of discretion to enable them to influence the relationship in their best interests. Shareholders desire to have an independent board of directors to protect their interests whenever the management takes actions that undermine the level of profitability in the organization ( Kahan & Rock, 2009 ). Independent shareholders have sufficient latitude and incentive to identify and arrest opportunistic actions by the company’s managers ( Patelli & Prencipe, 2007 ). The main corporate objective for most organizations is to enhance shareholder value. This objective has pushed most investors to buy shares in diligent companies that are run by independent board of directors. 

Effective corporate governance also requires the board of directors to maintain high levels of activity in the organization's affairs. They need to demonstrate high diligence by attending regular board meetings, maintaining integrity in their decision approaches, participating actively in the board meetings, conducting sufficient preparation before attending any meetings, paying attention to the contributions made in the board meeting, and making follow-ups on matters raised in the board meetings ( Anderson & Reeb, 2004 ). Corporate governance is enhanced when board members exercise diligence and high activity levels. 

Board members must possess the competence to achieve good corporate governance. The individuals enlisted in the board must all be qualified to make competent, rational decisions for the organization ( Abdel-Khalik, 2002 ). With proper qualification, the board members will have the ability to monitor the decisions and actions of the company’s management and proceed to sanction them where necessary. The desire to build a reputation as competent directors is the reason behind the present-day trend where people hold multiple directorships in several company boards ( Kahan & Rock, 2009 ). When a firm performs well during the tenure of a particular director, it boosts the reputation of the director by earning him more board seats in different companies. 

Question H. 

According to Abdel-Khalik (2002 ), s ome of the provisions within the corporate charter that may affect or determine the conduct of takeovers include: 

Provisions for the rights of shareholders 

Provisions that guide targeted share repurchases 

Policy plans for restricted rights of voters 

Question I. 

Companies make stock options as offers for their employees to buy some determined number of company shares at a determined price within some deadline period. The price is usually lower than the market price for the shares, and the employees have no obligation to buy the shares offered by the company- it is a matter of pure choice (Gompers, Ishii & Metrick, 2003). Many companies use stock options as a form of compensation to attract talented staff. 

Some potential problems for using stock options as compensation is that the senior executives who have bought shares tend to focus on short-term quarterly performance because they want to sell their shares when the price is high in the stock market ( Hermalin & Weisbach, 2001 ). Secondly, the stock option is bad for taxation because managers amend their earnings using stock options rather than taxable wages. 

Question J. 

Block ownership is a situation where individuals own large portions (block) of bond value or company share. When a block-holder buys large stakes in company shares, he acquires more voting rights that enable him to have a greater influence on how the corporation is governed ( Weston, Mitchell, Mulherin, Siu & Johnson, 2004 ). 

Question K. 

When companies register in jurisdictions that support investor interests through strong legal systems, then there is a high opportunity for such companies to access more financial markets ( Hermalin & Weisbach, 2001 ). Such jurisdictions also result in steady stock markets, high market liquidity, and reduced cost of equity. 

References 

Abdel-Khalik, A. R. (2002). Reforming corporate governance post-Enron: Shareholders' Board of Trustees and the auditor. Journal of Accounting and Public Policy ,  21 (2), 97-103. 

Anderson, R. C., & Reeb, D. M. (2004). Board composition: Balancing family influence in S&P 500 firms.  Administrative science quarterly ,  49 (2), 209-237. 

Coles, J. W., & Hesterly, W. S. (2000). Independence of the chairman and board composition: Firm choices and shareholder value.  Journal of Management ,  26 (2), 195-214. 

Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices.  The quarterly journal of economics ,  118 (1), 107-156. 

Hermalin, B. E., & Weisbach, M. S. (2001).  Boards of directors as an endogenously determined institution: A survey of the economic literature  (No. w8161). National Bureau of Economic Research. 

Hillman, A. J., & Dalziel, T. (2003). Boards of directors and firm performance: Integrating agency and resource dependence perspectives.  Academy of Management Review ,  28 (3), 383-396. 

Kahan, M., & Rock, E. B. (2009).  Hedge funds in corporate governance and corporate control . Routledge. 

Patelli, L., & Prencipe, A. (2007). The relationship between voluntary disclosure and independent directors in the presence of a dominant shareholder.  European Accounting Review ,  16 (1), 5-33. 

Schulze, W. S., Lubatkin, M. H., & Dino, R. N. (2003). Exploring the agency consequences of ownership dispersion among the directors of private family firms.  Academy of management journal ,  46 (2), 179-194. 

Weston, J. F., Mitchell, M., Mulherin, J. H., Siu, J. A., & Johnson, B. A. (2004). Takeovers, restructuring, and corporate governance. Prentice Hall