Question

Which of the following statements is NOT correct? (Please explain why answer E is correct)

a)corporate governance is the set of rules that control a company's behavior towards its directors, managers, employees, shareholders, creditors, customers, competitors, and community

b) agency problem is that managers may act in their own interests and not on behalf of stockholders.

c) Corporate governance is the set of rules that control a company's behavior towards its directors, managers, employees, shareholders, creditors, customers, competitors, and community.

d) corporate governance can help control agency problems

e) agency problems can be perfectly and permanently solved with corporate governance.

Answer 1

Agency iproblem iis ithat imanagers imay iact iin itheir iown iinterests iand inot ion ibehalf iof istockholders

The iagency iproblem iis ia iconflict iof iinterest iinherent iin iany irelationship iwhere ione iparty iis iexpected ito iact iin ianother's ibest iinterests. iIn icorporate ifinance, ithe iagency iproblem iusually irefers ito ia iconflict iof iinterest ibetween ia icompany's imanagement iand ithe icompany's istockholders. iThe imanager, iacting ias ithe iagent ifor ithe ishareholders, ior iprincipals, iis isupposed ito imake idecisions ithat iwill imaximize ishareholder iwealth ieven ithough iit iis iin ithe imanager’s ibest iinterest ito imaximize ihis iown iwealth.

1. Agency iproblem iis ia iconflict iof iinterest iinherent iin iany irelationship iwhere ione iparty iis iexpected ito iact iin ithe ibest iinterest iof ianother.

2. Agency iproblem iarises iwhen iincentives ior imotivations ipresent ithemselves ito ian iagent ito inot iact iin ithe ifull ibest iinterest iof ia iprincipal.

3. Through iregulations ior iby iincentivizing ian iagent ito iact iin iaccordance iwith ithe iprincipal's ibest iinterests, iagency iproblems ican ibe ireduced.

The iagency iproblem idoes inot iexist iwithout ia irelationship ibetween ia iprincipal iand ian iagent. iIn ithis isituation, ithe iagent iperforms ia itask ion ibehalf iof ithe iprincipal. iAgents iare icommonly iengaged iby iprincipals idue ito idifferent iskill ilevels, idifferent iemployment ipositions ior irestrictions ion itime iand iaccess. iFor iexample, ia iprincipal iwill ihire ia iplumber—the iagent—to ifix iplumbing iissues. iAlthough ithe iplumber‘s ibest iinterest iis ito icollect ias imuch iincome ias ipossible, ihe iis igiven ithe iresponsibility ito iperform iin iwhatever isituation iresults iin ithe imost ibenefit ito ithe iprincipal.

The iagency iproblem iarises idue ito ian iissue iwith iincentives iand ithe ipresence iof idiscretion iin itask icompletion. iAn iagent imay ibe imotivated ito iact iin ia imanner ithat iis inot ifavorable ifor ithe iprincipal iif ithe iagent iis ipresented iwith ian iincentive ito iact iin ithis iway. i

i i i i i i i i i i i i i i i i i i iAgency itheory iis iused ito iunderstand ithe irelationships ibetween iagents iand iprincipals. iThe iagent irepresents ithe iprincipal iin ia iparticular ibusiness itransaction iand iis iexpected ito irepresent ithe ibest iinterests iof ithe iprincipal iwithout iregard ifor iself-interest. iThe idifferent iinterests iof iprincipals iand iagents imay ibecome ia isource iof iconflict, ias isome iagents imay inot iperfectly iact iin ithe iprincipal's ibest iinterests. iThe iresulting imiscommunication iand idisagreement imay iresult iin ivarious iproblems iand idiscord iwithin icompanies. iIncompatible idesires imay idrive ia iwedge ibetween ieach istakeholder iand icause iinefficiencies iand ifinancial ilosses. iThis ileads ito ithe iprincipal-agent iproblem.

The iprincipal-agent iproblem ioccurs iwhen ithe iinterests iof ia iprincipal iand iagent iconflict. iCompanies ishould iseek ito iminimize ithese isituations ithrough isolid icorporate ipolicy. iThese iconflicts ipresent inormally iethical iindividuals iwith iopportunities ifor imoral ihazard. iIncentives imay ibe iused ito iredirect ithe ibehavior iof ithe iagent ito irealign ithese iinterests iwith ithe iprincipal's iconcerns.

Corporate igovernance iis ithe isystem iof irules, ipractices, iand iprocesses iby iwhich ia ifirm iis idirected iand icontrolled. iCorporate igovernance iessentially iinvolves ibalancing ithe iinterests iof ia icompany's imany istakeholders, isuch ias ishareholders, isenior imanagement iexecutives, icustomers, isuppliers, ifinanciers, ithe igovernment, iand ithe icommunity. iSince icorporate igovernance ialso iprovides ithe iframework ifor iattaining ia icompany's iobjectives, iit iencompasses ipractically ievery isphere iof imanagement, ifrom iaction iplans iand iinternal icontrols ito iperformance imeasurement iand icorporate idisclosure.

1. Corporate igovernance iis ithe istructure iof irules, ipractices, iand iprocesses iused ito idirect iand imanage ia icompany.

2. A icompany's iboard iof idirectors iis ithe iprimary iforce iinfluencing icorporate igovernance.

3. Bad icorporate igovernance ican icast idoubt ion ia icompany's ireliability, iintegrity, iand itransparency, iwhich ican iimpact iits ifinancial ihealth.

Governance irefers ispecifically ito ithe iset iof irules, icontrols, ipolicies, iand iresolutions iput iin iplace ito idictate icorporate ibehavior. iProxy iadvisors iand ishareholders iare iimportant istakeholders iwho iindirectly iaffect igovernance, ibut ithese iare inot iexamples iof igovernance iitself. iThe iboard iof idirectors iis ipivotal iin igovernance, iand iit ican ihave imajor iramifications ifor iequity ivaluation.

A icompany’s icorporate igovernance iis iimportant ito iinvestors isince iit ishows ia icompany's idirection iand ibusiness iintegrity. iGood icorporate igovernance ihelps icompanies ibuild itrust iwith iinvestors iand ithe icommunity. iAs ia iresult, icorporate igovernance ihelps ipromote ifinancial iviability iby icreating ia ilong-term iinvestment iopportunity ifor imarket iparticipants.

Corporate igovernance ican ibe iused ito ichange ithe irules iunder iwhich ithe iagent ioperates iand irestore ithe iprincipal's iinterests. iThe iprincipal, iby iemploying ithe iagent ito irepresent ithe iprincipal's iinterests, imust iovercome ia ilack iof iinformation iabout ithe iagent's iperformance iof ithe itask. iAgents imust ihave iincentives iencouraging ithem ito iact iin iunison iwith ithe iprincipal's iinterests. iAgency itheory imay ibe iused ito idesign ithese iincentives iappropriately iby iconsidering iwhat iinterests imotivate ithe iagent ito iact. iIncentives iencouraging ithe iwrong ibehavior imust ibe iremoved, iand irules idiscouraging imoral ihazard imust ibe iin iplace. iUnderstanding ithe imechanisms ithat icreate iproblems ihelps ibusinesses idevelop ibetter icorporate ipolicy.

To idetermine iwhether ior inot ian iagent iacts iin ihis ior iher iprincipal’s ibest iinterest, ithe istandard iof i“Agency iLoss” ihas iemerged ias ia icommonly-used imetric. iStrictly idefined, iagency iloss iis ithe idifference ibetween ithe ioptimal iresults ifor ithe iprincipal iand ithe iconsequences iof ithe iagent’s ibehavior. iFor iexample, iwhen ian iagent iroutinely iperforms iwith ithe iprincipal’s ibest iinterest iin imind, iagency iloss iis izero. iBut ithe ifurther ian iagent’s iactions idiverge ifrom ithe iprincipal’s ibest iinterests, ithe igreater ithe iagency iloss ibecomes.

Agency iproblems iare icommon iin ifiduciary irelationships, isuch ias ibetween itrustees iand ibeneficiaries; iboard imembers iand ishareholders; iand ilawyers iand iclients. iA ifiduciary iis ian iagent ithat iacts iin ithe iprincipal's ior iclients ibest iinterest. iThese irelationships ican ibe istringent iin ia ilegal isense, ias iis ithe icase iin ithe irelationship ibetween ilawyers iand itheir iclients idue ito ithe iU.S. iSupreme iCourt's iassertion ithat ian iattorney imust iact iin icomplete ifairness, iloyalty, iand ifidelity ito itheir iclients.