Question

Suppose you decide (as 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 records, and cell phones. Your initial market is the student body at your university. Once you have established your company and setup 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 issues 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. If you expanded and hired additional people to help you, might that give rise to agency problems?

3. Suppose you need additional capital to expand and you sell some stock to outside investors. If you maintain enough stock to control the company, what type of agency conflict might occur?

4. List three provisions in the corporate charter that affect takeovers.

Answer 1

1. Agency relationship:

The principal & agent together create an agency relationship. This is a business relationship where the principal gives legal authority to an agent to act on principal’s behalf when dealing with a third party. An agency relationship is termed as a fiduciary relationship.

No agency problem arises. An agency problem will arise when the manager owns less than 100% of the stock or the firm borrows. Since now only the owner money is invested, the manager owns 100% of the firm. As a single proprietary, you own the business in order to maximize your own welfare.

2. By expanding the business, agency problems can arise for sure. This is because an agency relationship exists between you & your employees, if you, the principal hired the employees to perform some task & delegates some decision making authority to them.

3. As the owner of the company, you would have enjoyed more perquisites such as more leisure, luxurious offices; generous retirement plans etc. however when the manager sells the stock to the outsiders, conflict of interests can happen immediately. We have to keep in mind that the value of perquisites still lies with the manager but now the cost has to be shared with the outsiders. This can make the managers to increase the consumption of perquisites.

4. Three provisions in the corporate charter:

• Targeted share repurchase (i.e. greenmail).
• Shareholder rights provisions (i.e. poison pills)
• Restricted voting right plans.