What Is An Agency Relationship When You First Begin ✓ Solved

What is an agency relationship? When you first begin

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

At some point, hopefully sooner rather than later, you plan to go public with an IPO and then to buy a yacht and take off for the South Pacific to indulge in your passion for underwater photography. With these plans in mind, you need to answer for yourself, and potential investors, the following questions: 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. Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs? What is corporate governance? List five corporate governance provisions that are internal to a firm and are under its control. Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation? Briefly explain how regulatory agencies and legal systems affect corporate governance.

Paper For Above Instructions

An agency relationship exists when one party (the principal) delegates authority to another party (the agent) to act on their behalf in business transactions. This relationship is characterized by the principal's trust in the agent to make decisions that are in the principal's best interest. In the context of a startup, the entrepreneur essentially acts as both the principal and the agent in the initial stages of the business, particularly if they are the sole employee and have invested their own resources.

In the early stages of the business, where the entrepreneur is the only employee and only their money is invested, agency conflicts may be minimal. This is because the entrepreneur directly controls all decisions and outcomes, and there is no divergence between personal motivations and company goals. However, as the business scales and additional stakeholders, such as investors and employees, are introduced, potential agency conflicts may arise due to differing interests and objectives.

When a business raises funds from outside lenders, several agency costs may occur. These costs arise from the conflicts of interest that can exist between the firm's owners (shareholders) and its creditors (lenders). For example, shareholders might be incentivized to engage in risky projects that could yield high returns, benefiting them but posing a substantial risk to lenders, whose interests lie in the firm's long-term stability and ability to repay the loans.

Lenders can mitigate agency costs through several strategies. First, they may impose covenants, which are provisions in loan agreements that restrict certain behaviors of the borrower, such as taking on more debt or engaging in riskier business operations. Second, lenders could require collateral, which acts as a security measure to protect their interests. By requiring tangible assets to be pledged against the loan, lenders ensure they have a fallback option in case of default. Lastly, thorough due diligence before granting loans can also help lenders assess the risk and monitor the company’s activities post-funding.

Corporate governance refers to the systems, principles, and processes that direct and control a company. Effective corporate governance ensures that a company is accountable to its shareholders and stakeholders and operates in compliance with laws and ethical standards. Five internal corporate governance provisions include: (1) a board of directors, which provides oversight of the management; (2) internal audit functions that assess the effectiveness of risk management and compliance; (3) performance evaluation processes for senior management; (4) executive compensation policies, including adherence to standards that prevent excessive risk-taking; and (5) shareholder rights provisions allowing for voting on significant company decisions.

Stock options are a form of equity compensation that allows employees to buy shares of the company at a predetermined price after a specified period, creating an incentive for employees to enhance the company's performance and, consequently, the stock price. However, there are potential problems with stock options as a compensation form. For instance, employee focus may shift towards short-term gains, leading to detrimental risk-taking behavior. Furthermore, stock options can lead to dilution of existing shareholders' equity if a large number of employees exercise their options simultaneously.

Regulatory agencies and legal systems profoundly affect corporate governance by establishing guidelines that companies must follow to ensure transparency, accountability, and ethical conduct. Regulations set by bodies such as the Securities and Exchange Commission (SEC) require firms to disclose financial information and adhere to accounting standards. This oversight helps maintain investor confidence and provides a regulatory backdrop against which corporate governance practices are assessed.

In summary, understanding agency relationships, agency costs, and corporate governance principles is critical for any entrepreneur starting a business. Careful consideration of how to manage these aspects effectively will not only help in maintaining a healthy operational model but also in navigating future growth, such as public offerings and expansion into larger markets. Navigating these complexities well can position a start-up for long-term success and sustainability.

References

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