Question

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:

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.

Answer 1

Requirement 1

No agency conflicts would be present. Agency conflicts usually occur each time the owner of the corporate possesses a lesser amount than 100% of the firm’s common stock. Meanwhile you are the one employee and the complete investment belongs to you, you own 100% of the firm. As a single owner seemingly you will activate the firm so as to exploit your own welfare, with welfare measured in the system of higher personal wealth, more relaxation, or freebies.

Requirement 2

Agency costs may comprise the prospective wealth loss instigated by the effect of debt in the firm’s investment judgments, the observing and connecting expenses by the lender and the manager and the insolvency and reformation costs. Tax subsidies on interest payments help to ease the agency costs.

Requirement 3

Corporate governance are the activities taken by industries and establishments that benefit to develop dealings with customers, stakeholders, the community, and business partners. These movements might comprise engaging in happenings in the community, endorsing corporate social responsibility, and supporting enhanced conservational performances. Five corporate governance provisions that are centre to a firm and are under its control are the aptitude to monitor and discipline by the board, charter provisions and by-laws that are called into play in the occurrence of a unfriendly coup, means of internal contol, compensation provisons, and any other factors that are outside of the firm’s control.

Requirement 4

Offer owner of option the right to purchase a share of the stock of the company at a indicated price (which is also referred as strike price) even if the actual strike price is higher. Usually cannot exercise the option for a number of years and cannot exercise the option after a definite number of years.

Manager can underachieve market or peer group, but still gain rewards from options as long as the prices of stock rises to above the exercise cost. Options occasionally embolden managers to fabricate financial statements or take extreme perils.

Requirement 5

Corporates in countries with excessive safeguard for investors tend to have improved entree to financial markets, a lower cost of equity, enhancement in market liquidity, and less noise in stock prices.