Question

In: Finance

5) Why does an “agency problem” exist in corporations?   Why is this problem unique to corporations...

5) Why does an “agency problem” exist in corporations?   Why is this problem unique to corporations and not partnerships or sole proprietorships? How can corporations minimize this problem?    (10pts)

6) What is the concept of tax inversion? Why is the practice attractive to U.S. corporations?   (5pts)

7) Who are “insiders” of a corporation? Why is illegal insider trading prohibited? Provide 2 examples of insider trading cases (provide names of the companies, the individuals involved, and the crime committed).    (10pts)

Solutions

Expert Solution

5) Agency problems exist in corporations as the management which is responsible for the daily operations of the organization are different from the owners or the shareholders of the organization. So it is probable that the agents (who are the management) would act in a manner for their own benefit which might be counter productive as far as interests of the owners are concerned and this would give rise to the agency problem.
This problem is unqiue to corporations and not occur in partnerships or sole propreitorship as in thse cases, the owner is also part of the management and thus confict of interest does not occur. The corporations can minimize this problem through a robust corporate governance model and ensuring that internal systems and controls are implemented well to protect shareholder interest.
6) The concept of tax inversion is that the company may shift the domicile of the organization to a place having lower tax rates while continuing to operate from a place which provides better resources and access to markets. This is attractive for corporations as it would ensure lower tax outflow and consequently better profits for the organization.
7) The insiders of an organization are key management personnel who are privy to information regarding the organization's investment plan, new product plans and growth opportunities into the future. The insider trading is illegal because the management professionals who are important may have assymetric information as compared to general public and they could use this information to generate unfair gains and this is absolutely prohibited.
The cases include:
1) Reebok insider trading case wherein a person named David Pajcin was ordered by SEC to pay $28 million of fines for trading in insider ifnormation based on tips from an investment banker.
2) Another improtant case was that of Mr. Rajat Gupta who was held for tipping his freind who was a hedge fund manager. He was involved with Goldman Sachs and held senior post in the firm.


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