External Financing: We Examined Two Important Topics In Fina ✓ Solved

External Financing We examined two important topics in finance

We examined two important topics in finance during this unit: external financing requirements and agency conflicts. Address the prompts below in your essay. Include an introduction that summarizes the main points with an example. Critically reflect on the importance of external financing requirements. What key factors must be considered when determining external financing requirements?

Briefly describe the types of agency conflict, and provide an example of at least one of the types of agency conflict to support your response. Your essay should be at least two pages in length, not counting the title and reference pages. You are required to cite and reference at least your textbook. Use APA format to cite in-text and reference citations.

Paper For Above Instructions

In the realm of finance, understanding the dynamics of external financing requirements and agency conflicts plays a crucial role in the sustainable growth of businesses. This essay aims to elucidate these concepts by first delving into the significance of external financing requirements, identifying critical factors influencing them, and then examining the various types of agency conflicts, complemented by illustrative examples. Throughout this analysis, I will underscore the interconnectedness of these two dimensions in the financial landscape.

Understanding External Financing Requirements

External financing refers to funds that a company raises through outside sources, rather than relying on internal sources like retained earnings. The necessity for external financing typically arises when a company seeks to embark on new projects, expand operations, or address short-term liquidity issues (Myers & Majluf, 1984). The importance of external financing requirements cannot be overstated; they serve as a lifeblood for businesses, allowing them to leverage opportunities that would otherwise be unattainable.

The critical factors that must be considered when determining external financing requirements include, but are not limited to:

• Project Viability: Assessing whether the projects or investments are financially viable is paramount. Companies must perform thorough due diligence to ensure that the expected returns justify the cost of financing.
• Cost of Capital: Understanding the cost of various financing options—equity, debt, or hybrid—ensures that companies make informed decisions that minimize financial expenses while maximizing returns (Brealey, Myers, & Allen, 2017).
• Market Conditions: Current economic conditions, including interest rates, inflation, and investor sentiments, play a crucial role in the availability and terms of external financing (Graham & Harvey, 2001).
• Regulatory Environment: Compliance with financial regulations and potential impacts of regulatory changes can affect a company’s ability to secure financing (Scott, 2015).

In conclusion, recognizing and assessing these factors equips companies with the necessary tools to navigate the complex decision-making processes surrounding external financing.

The Nature of Agency Conflicts

Agency conflicts arise from the relationships between stakeholders in a business, primarily between principals and agents. The principal-agent relationship is characterized by a conflict of interest, where agents (e.g., managers) are motivated to act in ways that may not align with the principals’ (e.g., shareholders’) best interests (Jensen & Meckling, 1976). Here are the three main types of agency conflict:

• Shareholder vs. Management: This conflict arises when management makes decisions that could benefit themselves more than the shareholders. For example, a CEO may prioritize personal perks over maximizing shareholder wealth, potentially resulting in excessive expenditure on luxury items or unnecessary expansions (Berk & DeMarzo, 2017).
• Shareholder vs. Creditors: Shareholders may desire to undertake projects that increase risk, which could jeopardize creditor interests. For instance, investing heavily in high-risk ventures could lead to a situation where creditors may not recover their investments if the company fails (Smith & Warner, 1979).
• Employee vs. Management: Conflicts may also arise between employees and management, where managers might implement policies that benefit the company but adversely affect employee compensation or job security (Sullivan & McMillan, 1991).

An illustrative example of the shareholder versus management conflict can be seen in the case of Enron, where executives pursued aggressive growth strategies driven by personal motivations, ultimately leading to the company's collapse and significant losses for shareholders (Healy & Palepu, 2003). This underscores the critical need for governance mechanisms that align the interests of management with those of shareholders, such as performance-based compensation.

Conclusion

In summary, external financing requirements are multifaceted and necessitate a comprehensive analysis of various factors that influence decisions in raising capital. Simultaneously, understanding the types of agency conflicts provides insights critical to devising strategies that mitigate these issues. Through appropriate governance and management practices, companies can align interests efficiently, thereby ensuring financial health and long-term sustainability.

References

• Berk, J., & DeMarzo, P. (2017). Corporate Finance (4th ed.). Pearson.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance (12th ed.). McGraw-Hill Education.
• Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60(2-3), 187-243.
• Healy, P. M., & Palepu, K. G. (2003). The fall of Enron. Journal of Economic Perspectives, 17(2), 3-26.
• Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics, 3(4), 305-360.
• Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187-221.
• Scott, W. R. (2015). Financial Accounting Theory (7th ed.). Pearson.
• Smith, C. W., & Warner, J. B. (1979). On financial contracting: An analysis of bond covenants. Journal of Financial Economics, 7(2), 117-161.
• Sullivan, D. M., & McMillan, J. (1991). Agency conflicts, market completion and capital structure. Journal of Business Finance & Accounting, 18(4), 575-594.