Agency Relationship and Corporate Governance Case Study
- Details
- Hits: 9931
Case study on Agency investment
I have decided to start a company, and my product will be a software program that integrates a wide range of media devices, including laptop computers, desktops computers, digital video recorders, and cell phones. My initial client base is the student body at my university. Once I have established my company and set up procedures for operating it, I plan to expand to other colleges in the area and eventually to go nationwide. At some point, hopefully, sooner rather than later, I plan to go public with an IPO and then buy a yacht and take off for the South Pacific to indulge in my passion for underwater photography. With these plans in mind, I need to have full information for myself and potential investors concerning the following:
An agency relationship
An agency relationship is an interrelation between individuals or organizations where a fiduciary represents another person or organization by acknowledging that the interests of the party they are representing always dominate. The agent must preserve trust and the good faith of the party they are representing, which is the principal. The agent is under the control of the principal and hence consents of the principal's instructions. Both parties only need to consent for the agency relationship to happen. The manifestation of the agreement can be in writing or oral. However, some agency relationships are circumstantial and happen with no explicit agreement (Baker, 2019).
When I first begin operations, assuming I am the only employee and only my money is in the investment, there would be no existence of agency conflict because I would not have appointed anyone to act in my best interest. Agency conflicts exist where there is a relationship, and one party expects the other to act on its behalf. However, if conflicts of interest arise between the agent and the principal, the agency conflict happens. Conventionally, according to Business Law, an agent ought to make decisions that would result in maximum shareholder wealth, although it is the agent's best interest to maximize their wealth (Baker, 2019).
Type of agency cost
Supposing my company raises funds from outside lenders, the company might incur agency costs in the process. A company might incur internal expenses because of the conflicting interest of the principals who are the shareholders and the agents that are in the management. In this context, such an internal cost link to the process of resolving agency conflicts and in managing the agency relationship. For instance, the shareholders might want to optimize their value in the company while the agents might as well make decisions and act against the interests of the principals to benefit themselves. For example, if my company raises funds from outside lenders, the type of agency cost that might occur is agency cost of debts, which is the rise in the value of debt or placement of debt covenants for worries about agency cost issues. Since my outside lenders would not be in control of their funds, agency cost of debt would happen if the lenders fear that my managers might take part in risky activities that convenience shareholders better than bondholders. Such fears of principal-agent issues in the organization might motivate the outside lenders to place constraints like debt covenants on how the company uses the money (Baker, 2019).
Lenders might mitigate agency costs by implementing incentive schemes that might be financial or non-financial. Since financial strategies work better than non-financial ones, the lenders may decide to give a monetary bonus to the management team if my company realizes a set target. Such a financial incentive that rewards performance is motivational for the management to perform in the best interest of the organization (Baker, 2019).
Corporate governance
Corporate governance is a network of regulations, practices, and procedures by which stakeholders control and direct an agency. Corporate governance fundamentally regards stabilizing the interests of an organization’s several stakeholders, like shareholders, executives in senior management positions, clients, and suppliers, outside lenders, the government's authority, and the neighboring community. Corporate governance also offers the foundation for the company to achieve its mission; it encircles virtually all the spheres of executive management, which include planning, internal controls, performance evaluation as well as corporate disclosure (Ibrahim and Lode, 2020).
Corporate governance provisions
The following corporate governance provisions are internal to a firm and are under its control (Ibrahim and Lode, 2020):
Classified board
The firm forms a board by dividing the directors into different classes and electing them to overlapping terms (Ibrahim and Lode, 2020).
Fire-price Charter adjustment
This provision makes it necessary for a substantial shareholder to finance a price that a particular formula sets for every share received in the rear end of a two-tier possession (Ibrahim and Lode, 2020).
Present-day (within three years) reintegrating to Delaware
Under this provision, a firm can alter its state of embodiment to reinforce their antitakeover protections (Ibrahim and Lode, 2020).
Supermajority vote precondition
This provision sets up an extent of approval for specific actions, which is above the minimum that the state law has set (Ibrahim and Lode, 2020).
Differing voting rights
This provision happens when there are different voting rights for common shares. For instance, in dual-class capitalization, there is one class of stock with superior voting rights to the other (Ibrahim and Lode, 2020).
The use of stock options in a compensation plan
Stock options are a structure of compensation that a firm can grant to an employee, contractor, investor, or consultant. Stock options take the form of contracts and offer an employee the privilege to buy a certain amount of shares of the organization at a predetermined value referred to as the grant price. However, the offer lasts for a period in which the employee must exercise the available options before expiration. That can either be while working for the company or upon ceasing to be its employee. These options differ for different companies and with the position and expertise of the employee. The stakeholders of the company must sign off for the stock options before the employee can buy them (Ibrahim and Lode, 2020).
Some potential problems with stock options as a form of compensation
Stock options can complicate the tax undertones for employees. Stock options lead to share dilution as it comes as additional stock and can be expensive to shareholders in the end. Another potential problem is the difficulty in valuing stock options. Additionally, in the case of non-performing executives posting poor results, stock options happen as a high level of compensation. Last, yet of importance for an individual employee to benefit from stock options, the employee must depend on the collective effort of co-workers and leadership (Ibrahim and Lode, 2020).
How regulatory agencies and legal systems affect corporate governance
Regulatory agencies and legal systems affect corporate governance by aligning the interest of shareholders, leadership, and the board of directors. The law provides a common framework for the three actors to interact. It is also the role of the regulatory agencies to protect shareholders and simultaneously allow the board of directors and the managers to execute their responsibilities for the growth of the company hence adding value for its shareholders. Regulatory agencies and legal systems ensure that the right regime, professional standards, and implementations are thriving and put in the application according to corporate governance principles. That is paramount because the continuous evolution of financial services demands adherence to organizational ethics, policies, and standards of operations by all the stakeholders for the stability and growth of the company. Regulatory agencies and legal systems also clearly communicate and encourage effective practices to market participants (Ibrahim and Lode, 2020).