Finance Capital

1. 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.
Agency relationship is delineated as the relationship between the principal and agent. It is an association within the business that provides the principal with legal authority to an agent in order to act on behalf of the principal when transacting with a third party. Agency conflicts would not exist. More often than not agency conflicts emanated when an owner of the firm possesses less than 100 percent of the common stock of the firm. In this case, taking into consideration that there is solely one employee and the complete investment belongs to you, then ownership is 100 percent.
2. If you expanded and hired additional people to help you, might that give rise to agency problems?
Through the expansion of the business and employing extra people for assistance may result in agency problems. Imperatively, an agency relationship could come into existence between you and your personnel if you employed them to offer some service and granted them power and authority to make decisions.
3. 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?
The key conflict that comes about when selling stock to outsiders is that one does not have 100 percent control of the entity anymore. It is imperative to note that there is a greater advantage to being a sole owner. By having shared ownership irrespective of the amount of control in possession, some of these benefits are lost, for instance income. That is, the earnings generated have to be shared with the other stakeholders.
4. Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs?
As delineated agency costs are a form of internal outlay that emanates from or is compensated to an agent that acts on behalf of a principal. These outlays come about owing to fundamental issues, for instance the conflict of interest that exists between the management and stakeholders. In this particular instance, an agency cost that might take place is high rates of interest that can be lent by a creditor on risky loans. There are ways of diminishing this cost. Notably, a lender can safeguard himself or herself against the agency costs by instituting limiting contracts in debt agreements and ensuring their loans are secured.
5. 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.
The potential managerial behaviors that can harm the value of a firm include the following:
i. Evading tough and challenging decisions owing to associations to individuals such as family and friends
ii. Evading projects that have positive net present values but are risky to ensure that they do not have a bad perception in the event that the project fails to success and taking on projects that have negative net present value but are risky and trying to attain success
iii. Altering information proclamations in order to evade the provision of poor news
iv. Using very minimal time, resources and endeavor
v. Utilizing very many non-pecuniary benefits
vi. Avoiding returning capital to investors in order to make investment to securities
6. What is corporate governance? List five corporate governance provisions that are internal to a firm and are under its control.
Corporate governance takes into account the practices and the regulations employed to control and offer direction to the business operations of an entity. Corporate governance tries to attain a balance between the different stakeholders. Corporate governance provisions that are internal to an organization and ate under its control comprise of the following:
i. Proposing an espousing a capital structure that is optimum
ii. Generating by-laws and also provisions to preclude any hostile takeover
iii. Assessing and checking the performance of the directors
iv. Monitoring and observing the business accounting system and conducting changes if necessitated
7. What characteristics of the board of directors usually lead to effective corporate governance?
The following are characteristics of board of directors that more often than not give rise to effective governance:
i. Ensuring the CEO and the Board Chairman are different individuals
ii. A great deal of the board of members are external to the company
iii. The board of directors does not comprise of several people
iv. The board members are given appropriate compensation
8. List three provisions in the corporate charter that affect takeovers..
i. Rights and provisions of the shareholders
ii. Controlling the voting rights of the members
iii. Repurchasing of specific shares as treasury stocks
9. 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 are amongst one of the approaches espoused and implemented by corporations for the compensation of its personnel. In this method, the personnel are offered the company’s stocks which are issued at a predetermined price also referred to as the strike price. These stock options are beneficial in the promotion of longstanding relationships with the employees and at the same time enable a great extent of dedication amongst the personnel.
Some of the problems with stock options for compensation include the following:
1. It can cause the managers to conduct manipulations while preparing financial statements in order to increase the price of the stock
2. The managers issues with stock options will be granted high compensation regardless of the company’s poor financial performance
10. What is block ownership? How does it affect corporate governance?
Block ownership is a form of ownership that is generated when an outsider or external party owns a huge proportion of the total shares of a corporation. In these sorts of instance, the block owner assumes control of the corporation. Notably, block ownership impacts corporate governance in that it causes the block owner to impact the decision based on his endeavor by utilizing the voting right. In addition, it leads to increased monitoring of the managers incessantly
11. Briefly explain how regulatory agencies and legal systems affect corporate governance.
Regulatory agencies and legal systems impact corporate governance in the sense that they safeguard the investors from experiencing exploitation from shareholders with the majority vote or the block owners. In addition, they make it possible for corporations to attain rapid accessibility to the financial markets and also have a better capability of raising equity.