Finance HW assignment Topic : Agency Conflicts and Corporate Governance

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Assignment for chapter 13 – BF 431
Topic : Agency Conflicts and Corporate Governance
Limiting your answers to the bullet points from the slides will not give you full credit. You
have to explain concepts in your own words. Turnitin will be used.
Question 1: 5 lines minimum
What are the potential agency conflicts between inside owners and outside shareholders?
Question 2:5 lines minimum
What are the agency costs associated with debt? How can they be mitigated?
Question 3: 10 lines minimum
List 6 examples of managerial behavior that can affect firm value in a negative way and explain
tham.
Question 4: 10 lines minimum
List 5 corporate governance mechanisms that are internal and under the firm’s control. Explain
how they can improve the firm’s value.
Question 5: 10 lines
What characteristics of the board of directors usually lead to effective corporate governance?
Question 6: 5 lines
What is block ownership? How does it affect corporate governance?
Question 7: 20 lines minimum
Based on your answers in question 5, assess the quality of the board of directors of Tesla and
Renault. Compare and explain. Find two articles (one for each firm) talking about the
roles/results of their CEOs. Link the articles to corporate governance quality.
CHAPTER 13
Corporate Governance
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Topics in Chapter
• Agency Conflicts
• Corporate Governance
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Corporate Governance and Corporate Value
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What is an agency relationship?
An agency relationship arises whenever one or more
individuals, called principals, (1) hires another individual or
organization, called an agent, to perform some service and
(2) then delegates decision-making authority to that agent.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
If you are the only employee, and only your money is
invested in the business, would any agency problems exist?
No agency problem would exist. A potential agency
problem arises whenever the manager of a firm owns less
than 100 percent of the firm’s common stock, or the firm
borrows. You own 100 percent of the firm.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Would hiring additional people create
agency problems?
An agency relationship could exist between you and your
employees if you, the principal, hired the employees to
perform some service and delegated some decisionmaking authority to them.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Owner/managers versus Outside Shareholders
• Benefits of being an owner/manager:
• Increase wealth due to owning company
• Perquisites (perks):
• Luxurious offices
• Executive assistants
• Expense accounts
• Limousines and auto allowances
• Country club memberships
• Generous retirement plan
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Who bears the costs of the perks?
• If the owner/manager owns all the stock, the
owner/manager bears all costs.
• If there are also outside shareholders, they bear some of
the cost due to the owner/manager’s perks.
• Therefore, minority shareholders will pay less for shares
of stock—this is an agency cost.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Borrowers versus Lenders
• After the loan is originated, borrowers can make
decisions that affect the lender:
• Invest in risky projects.
• Who benefits most if there is a small payoff, medium payoff, or big
payoff?
• Who loses most if there is a small loss, medium loss, or big loss?
• Take on additional debt
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Agency Cost of Debt
• Creditors anticipate possible harmful actions by
stockholders
• Creditors charge higher interest rate.
• Company’s cost of capital goes up.
• Value of company goes down.
• This is an agency cost.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What actions reduce agency cost of debt?
• Securing the loan with company’s assets.
• Placing restrictive covenants in debt agreements. The
borrower must:
• Maintain profitability ratios and retained earnings at a
certain level before making any distributions to
shareholders.
• Maintain debt ratios at specified levels.
• Not issue more debt.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Modern Corporation
• Many shareholders, none who own a controlling
interest in the company.
• Decision-making delegated by shareholders to an
elected board of directors.
• Board delegates most decision-making to hired
executives, who then hire other employees and
delegate some decision-making.
• Potential agency conflict between shareholders and
managers.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Six Potential Problems with Managerial
Behavior (1 of 2)
• Expend too little time and effort.
• Consume too many nonpecuniary benefits.
• Avoid difficult decisions (e.g., close plant) out of loyalty
to friends in company.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Six Problems with Managerial
Behavior (2 of 2)
• Reject risky positive NPV projects to avoid looking bad
if project fails; take on risky negative NPV projects to
try and hit a home run.
• Avoid returning capital to investors by making excess
investments in marketable securities or by paying too
much for acquisitions.
• Massage information releases or manage earnings to
avoid revealing bad news.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Corporate Governance
• The set of laws, rules, and procedures that influence a
company’s operations and the decisions made by its
managers.
• Sticks (threat of removal)
• Carrots (compensation)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Corporate Governance Provisions Under
a Firm’s Control
• Board of directors
• Charter provisions affecting takeovers
• Compensation plans
• Capital structure choices
• Internal accounting control systems
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effective Boards of Directors (1 of 4)
• Election mechanisms make it easier for minority
shareholders to gain seats:
• Not a “classified” board (i.e., all board members elected
each year, not just those with multi-year staggered terms)
• Board elections allow cumulative voting
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effective Boards of Directors (2 of 4)
• CEO is not chairman of the board and does not have
undue influence over the nominating committee.
• Board has a majority of outside directors (i.e., those
who do not have another position in the company) with
business expertise.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effective Boards of Directors (3 of 4)
• Is not an interlocking board (CEO of company A sits on
board of company B, CEO of B sits on board of A).
• Board members are not unduly busy (i.e., set on too
many other boards or have too many other business
activities)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effective Boards of Directors (4 of 4)
• Compensation for board directors is appropriate
• Not so high that it encourages cronyism with CEO
• Not all compensation is fixed salary (i.e., some
compensation is linked to firm performance or stock
performance)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Anti-Takeover Provisions
• Targeted share repurchases (i.e., greenmail)
• Shareholder rights provisions (i.e., poison pills)
• Restricted voting rights plans
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Stock Options in Compensation Plans (1 of 2)
• Gives owner of option the right to buy a share of the
company’s stock at a specified price (called the strike
price or exercise price) even if the actual stock price is
higher.
• Usually can’t exercise the option for several years
(called the vesting period).
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Stock Options in Compensation Plans (2 of 2)
• Can’t exercise the option after a certain number of
years (called the expiration, or maturity, date).
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Problems with Stock Options
• Manager can underperform market or peer group, yet
still reap rewards from options as long as the stock
price increases to above the exercise cost.
• Options sometimes encourage managers to falsify
financial statements or take excessive risks.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Block Ownership
• Outside investor owns large amount (i.e., block) of
company’s shares
• Institutional investors, such as CalPERS or TIAA-CREF
• Blockholders often monitor managers and take active
role, leading to better corporate governance
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Regulatory Systems and Laws
• Companies in countries with strong protection for
investors tend to have:
• Better access to financial markets
• A lower cost of equity
• Increased market liquidity
• Less noise in stock prices
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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