Ch 13: Assignment - Corporate Governance

2. Agency conflicts between managers and shareholders

Remember, an agency relationship can degenerate into an agency conflict when an agent acts in a manner that is not in the best interest of his or her principal. In large corporations, these conflicts most frequently involve the enrichment of the firms executives or managers (in the form of money and perquisites or power and prestige) at the expense of the companys shareholders. This usurping and reallocation of shareholder wealth is most likely to occur when shareholders do not have sufficient information about the decisions and actions being made by the firms management.

Consider the following scenario and determine whether an agency conflict exists:

Jacob and Kayla equally own and manage A New Beginning (ANB), a store that sells preowned clothing and furniture. Jacob is responsible for ANBs back-office activities, and Kayla staffs the store and makes deliveries to customers. Both have equal decision-making authority and, under the terms of their partnership agreement, both are prohibited from making personal purchases using company funds without prior approval of the other partner. Jacob, without Kaylas knowledge, used the companys bank account recently to purchase a new sports car. Jacob has acknowledged that the car will not be used to support the business.

Is this a potential agency conflict between Jacob and Kayla?

No; Jacob and Kayla co-own and co-manage ANB and have a partnership agreement that makes them equal, so an agency conflict cannot exist.

No; Jacob and Kayla are both authorized to spend ANBs money, so no conflict of interest can occur.

Yes; it should have been Kayla who purchased the car.

Yes; Jacob is misappropriating some of Kaylas wealth by unilaterally purchasing a nonbusiness asset using ANBs funds.

Consider the following scenario and determine whether an agency conflict exists:

Five years ago, Hasan created a plant-care business that grew, stocked, and maintained fresh plants in office buildings throughout Oklahoma City. Over time, The Green Zone Inc. (TGZ) has grown from a proprietorship into a corporation, now reaching far beyond Oklahoma City. To finance and support this growth, TGZ issued shares that were sold to TGZ employees, Hasans family members, and selected outsiders. Hasan is TGZs chairman of the board of directors and CEO, but he is no longer the largest shareholder.

At the latest annual meeting, two mutually exclusive proposals were placed on the ballot for discussion and vote. The first was put forth by Hasan and TGZs management team, and the second was proposed by a small group of other shareholders. Both groups are adamantly opposed to the other groups proposal, even though both proposals would likely have the same effect on TGZs value and riskiness.

Does an agency conflict exist between TGZs management and the small group of opposing shareholders?

No; Hasan was the original owner of TGZ, so he would always be sensitive to the concerns of the firms current owners (shareholders) and would not engage in an agency conflict.

Yes; any conflict or disagreement between the firms managers and its shareholders constitutes an agency conflict.

Yes; an agency relationship exists, and an agency relationship always gives rise to agency conflicts, regardless of the actual behavior of the participants.

No; although an agency relationship exists between TGZs managementincluding Hasan as TGZs chairman and CEO and the firms shareholdersthere is no agency conflict, because no expropriation or wasting of the shareholders wealth has occurred.

Consulting firms and human resource departments have spent innumerable hours attempting to develop executive compensation programs that will align the goals of a firms managers with those of the firms shareholders. Which of the following compensation packages is most likely to accomplish this task?

An annual salary of $800,000

An annual salary of $500,000 and a stock option bonus package that provides 100,000 shares after one year

An annual salary of $250,000 and a stock option bonus package that provides 250,000 shares after five years

An annual salary of $500,000 and a stock option bonus package for a total of 250,000 shares, with 50,000 shares vesting at the end of each of the next five years

In addition to well-designed executive compensation packages, two other motivational forces can align the interests of managers with those of their shareholders. Which of the following actions could be used to reduce the potential for these agency conflicts and ensure that the firms managers will pursue the long-term wealth interests of their shareholders?

Let the manager know that he or she will be fired if the companys stock does not reach a certain target by the end of the year.

Let the manager know that a takeover is possible if he or she doesnt perform well.

Suppose a new law made it more difficult to stage a hostile takeover. Which of the following groups would benefit the most?

Bondholders

Small individual investors

Management