Week 6 HW

1. Agency Relationship and Agency Conflicts

An agency relationship is a fiduciary relationship that results from consent manifestation from one individual to another individual, in that the second individual acts on behalf of the first individual besides working under his control and consent. 

When I am the only one running a business, there would be no agency conflict. Most of the time, agency problems arise when a manager does not own the entire common stock or the firm borrows (Banks et al., 2018 and Panda and Leepsa, 2017). Therefore, there would be no agency problem, as I would own the entire firm. Moreover, a sole proprietorship is about maximizing one’s welfare; in this case, welfare is measured through increased personal wealth, perquisites, or more leisure.

2. Agency costs

Borrowers make decisions after a loan is made. The action leads to an agency conflict between the borrowers and the lenders as the afterward decisions of the borrowers affect the lenders (Delbufalo, 2018). For instance, a borrower can take an additional debt or invest in a risky project, making a lender to charge beyond the normal interest because of the potential loss. Agency cost is the higher interest rate here. Lenders can protect themselves through securing their loans and placing restrictive covenants in the agreements of the debts.

3. Corporate  Governance

Corporate governance is a system of rules, processes, and practices controlling and directing a firm. It ensures that all the decisions taken are beneficial to the company (Banks et al., 2018). It is also a mitigatory measure that ensure peaceful co-existence between stakeholders and management. 

The five corporate governance provision include:

• Accounting control.
• Plans for compensation.
• Capital structure decisions.
• Board of directors monitoring.
• By-laws change or in-laws indicate a potential threat of taking over.

4. Stock Options

It provides owners with an option of buying a share of stock of the company at a specified price (strike price) even with a higher actual stock price. However, Delbufalo (2018) claims that they are restricted from performing the option for a couple of years (vesting period) and beyond a specified period (maturity or expiry date). According to Panda and Leepsa (2017), managers can underperform the peer group or market and still be beneficiaries of options when stock price exceeds the cost of the exercise.

5. Impact of Legal Systems and Regulatory Agencies on Corporate Governance

A company in a country with a strong investor is likely to have better access to financial markets, less stock price noise, increased liquidity in the market, and a lower equity cost.

References

Banks, G. C., Woznyj, H. M., Kepes, S., Batchelor, J. H., & McDaniel, M. A. (December 07, 2018). A meta-analytic review of tipping compensation practices: An agency theory perspective. Personnel Psychology, 71, 3, 457-478.

Delbufalo, E. (January 01, 2018). Agency Theory and Sustainability in Global Supply Chain.Panda, B., & Leepsa, N. M. (June 01, 2017). Agency theory: Review of theory and evidence on problems and perspectives. Indian Journal of Corporate Governance, 10, 1, 74-95.