Question

Suppose you own stock at AC Milan Berhad. The current price per share is RM30. Another company has just announced that it wants to buy your company and will pay RM40 per share to acquire all the outstanding stock. Your company’s management immediately begins fighting off this hostile bid. Is management acting in the shareholders’best interest? Elaborate on your opinion on this matter.

Profitability based on short-term goals could be at the expense of long term sustainability of an organization, discuss.

Critically evaluate main reasons that an agency relationship exists in the corporate form of organization.

Answer 1

a. Before evaluating an acquisition, or a bid from prospective buyer, the management and the stockholders should consider the expected value of the company in the future years. The offer from other company to pay RM 40 is no worth accepting if the future expected value of each share is greater than 40.

The shareholder / management has to carefully estimate the future value of share (which can be calculated using Expected earnings method or Dividend model, etc.). If the perceived value is greater, then the bid should not be accepted.

b. Profitability in the short run may not ensure that the organization sustains in the long run in the economy. The objective of the business is to maximize its wealth. Profit making objective will not help the business survive in the long run.

It is because the objective of profit making ignores the aspects of time value of money and risk factor. Profit making objective will make the management make riskier decisions in pursuit of high profits. Profit making objective also ignores the timing of the outflows and inflows.

The long term sustainability of the organization depends on the achievement of objectives, long term strategies, leadership roles, etc.

c A principal–agent relationship (also known as an agency relationship) is created when a principal hires an agent to perform a particular task or service. The agency relationship exists in the following areas:

Shareholder and Manager / Director relationships: Shareholders appoint the directors to manage the company’s affairs. As a part of this responsibility, the directors make the strategy and implement it through managers. The directors must act in the best interests of shareholders. In some situations, managers may seek to maximize their personal benefit. The shareholders might be more risk tolerant than the managers which also leads to conflicts.

Controlling and Minority Shareholder relationships: In companies with minority shareholders, the opinions of minority shareholders may be outweighed or shadowed by the influence of controlling shareholders. Mainly in cases of related party transactions, the controlling shareholders may place their interests ahead of minority shareholders’ interests.

Shareholders vs Creditor Interests: Shareholders would prefer riskier projects whereas creditors would likely prefer stable performance and lower-risk activities.

Conflicts also exist between customers and shareholders, shareholders and regulators, etc.