Mini Case Instructions: Answer The Following Questions ✓ Solved

Mini Case Instructions Answer the following questions in a

Explain how you reached the answer or show your work if a mathematical calculation is needed, or both.

Suppose you decide (as did Steve Jobs and Mark Zuckerberg) to start a company. Your product is a software platform that integrates a wide range of media devices, including laptop computers, desktop computers, digital video recorders, and cell phones. Your initial client base is the student body at your university. Once you have established your company and set up procedures for operating it, you plan to expand to other colleges in the area and eventually to go nationwide.

With these plans in mind, you need to answer for yourself, and potential investors, the following questions:

1. What is an agency relationship? When you first begin operations, assuming you are the only employee and only your money is invested in the business, would any agency conflicts exist? Explain your answer.
2. Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs?
3. What is corporate governance? List five corporate governance provisions that are internal to a firm and are under its control.
4. Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation?
5. Briefly explain how regulatory agencies and legal systems affect corporate governance.

Paper For Above Instructions

Starting a company is both an exhilarating and challenging task, reminiscent of the journeys undertaken by pioneering entrepreneurs such as Steve Jobs and Mark Zuckerberg. This paper aims to answer critical questions about agency relationships, agency costs, corporate governance, stock options in compensation plans, and the influence of regulatory agencies and legal systems on corporate governance.

1. Understanding Agency Relationships

An agency relationship arises when one party (the principal) delegates decision-making authority to another party (the agent). The agent is expected to act in the best interest of the principal. In the beginning stages of my company, where I am the sole employee and investor, there would be virtually no agency conflicts. Since I solely control both ownership and operational decisions, there is alignment in goals and incentives. This is often termed a “single-principal agency relationship,” where the risk of conflicting interests is minimized (Klein, 2017).

2. Agency Costs from Outside Lenders

As the business grows and I seek external financing from lenders, agency costs may arise. These costs arise due to the potential misalignment of interests between the lenders (creditors) and the management (borrowers). For instance, my management decisions to invest in high-risk projects could jeopardize loan repayment (Jensen & Meckling, 1976). Lenders can mitigate these agency costs by implementing stringent loan covenants, monitoring financial performance, requiring collateral, and establishing regular reporting mechanisms (Harris & Raviv, 1979).

3. Corporate Governance Defined

Corporate governance encompasses the systems, principles, and processes by which a company is controlled and directed. Five internal corporate governance provisions include:

• Board Structure: Composition and independence of the board of directors.
• Executive Compensation Policies: Framework for compensating executives that align their interests with shareholders.
• Shareholder Rights: Mechanisms that enable shareholders to exercise their voting rights and influence decision-making.
• Audit Committees: Independent oversight to ensure financial integrity and compliance.
• Internal Controls: Procedures to safeguard assets and ensure the reliability of financial reporting.

4. Stock Options in Compensation Plans

Stock options are a form of equity compensation that gives employees the right to purchase company stock at a predetermined price. They are designed to align employee interests with those of shareholders, motivating employees to enhance company performance. However, potential problems include the short-term focus on stock price rather than long-term company health and excessive risk-taking, as employees may aim to maximize stock value in the short run (Bebchuk & Fried, 2003).

5. Impact of Regulatory Agencies and Legal Systems

Regulatory agencies and legal systems significantly shape corporate governance. They establish frameworks that ensure accountability, transparency, and fair treatment of stakeholders. For instance, securities regulations prevent fraud and protect investors. Moreover, corporate compliance necessitates adherence to legal standards, which can influence a company’s policies, procedures, and overall governance structure (Coffee, 2007).

In conclusion, understanding agency relationships, agency costs, corporate governance frameworks, compensation mechanisms, and the ramifications of regulatory oversight is crucial for the successful operation and growth of a company. These considerations not only influence internal decision-making but also depict the health and resilience of the organization in the eyes of potential investors.

References

• Bebchuk, L. A., & Fried, J. M. (2003). Executive Compensation as an Agency Problem. Harvard Law Review, 116(1), 59-120.
• Coffee, J. C. Jr. (2007). Gatekeepers: The Professions and Corporate Governance. Oxford University Press.
• Harris, M., & Raviv, A. (1979). Control of Managers: Ownership and Incentives. Quarterly Journal of Economics, 93(3), 197-218.
• 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.
• Klein, P. G. (2017). Knowledge and the Firm. International Journal of Managerial Finance, 13(2), 167-183.
• Williamson, O. E. (1985). The Economic Institutions of Capitalism. Free Press.
• Fama, E. F., & Jensen, M. C. (1983). Separation of Ownership and Control. Journal of Law and Economics, 26(2), 301-325.
• Shleifer, A., & Vishny, R. W. (1997). A Survey of Corporate Governance. Journal of Finance, 52(2), 737-783.
• Cohen, L., Dey, A., & Lys, T. (2008). Real and Accrual-Based Earnings Management in the Aggregate and by Industry. American Accounting Association.
• Agrawal, A., & Knoeber, C. R. (1996). Firm Performance and Mechanisms to Control Agency Problems Between Managers and Shareholders. Journal of Financial and Quantitative Analysis, 31(3), 377-397.