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14 Jan 2018

Agency Problems Who owns a corporation? Describe the process whereby the owners control the business’ management. What is the main reason that an agency relationship exists in the corporate form of organization? In this context, what kinds of problems can arise?

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Irving Heathcote
Irving HeathcoteLv2
15 Jan 2018

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1. AGENCY PROBLEMS Who owns a corporation? Describe the processwhereby the owners control the firm’s management. Describe the mainreason why an agency relationship exists in the corporate form oforganization. In this context, describe the types of problems thatcan arise.

2. ENTERPRISE VALUE A firm’s enterprise value is equal to themarket value of its debt and equity, less the firm’s holdings ofcash and cash equivalents. This figure is particularly of interestto potential purchasers of the firm. Why?

3. CURRENT RATIO Explain what it means for a firm to have acurrent ratio of .50. Would the firm be better off with a currentratio of 1.50? What if it were 15.0? Explain your answers.

4. SALES FORECASTS Why do you think most long term financialplanning begins with sales forecasts? Stated differently, why arefuture sales the key input?

Bill Jobs has decided to start a computer company called CompU in Joplin. He knows that many MSSU students, who are now required to own and operate a personal computer, are having difficulty setting up their computers, accessing various materials from MSSU’s network and from the internet, and installing new programs as they become available. Bill’s plan is to provide a service to the students by helping students set up their computers, show them how to access various databases, and offer an e-mail help desk for any problems that arise. Bill also wants to develop a website that will be a seamless portal to the internet and the campus intranet.

If things go well, Bill plans to sell computers with all the required software preinstalled to students, and develop the website that includes links to various businesses and services that students like, and to offer advertising services (and charge for the links) to local businesses. For example, a student could use the web site to order pizza delivery while studying for a financial management exam.

Once Bill has established CompU and developed the necessary operating procedures, he plans to expand to other colleges and universities in the area, and eventually go nationwide. At some point Bill plans to take CompU public with an IPO.

1. When Bill first begins CompU, if he is the only employee and only his money is invested in the company, would any agency problems exist? As he expands and hires additional people at CompU, might agency problems arise? When Bill first begins, what type of business organization will CompU be?

2. If Bill needs capital to buy his computer inventory to sell to students or develop software to run the website and the business, might this lead to agency problems? Would it matter if the new capital came in the form of an unsecured bank loan, a bank loan secured by the inventory, or from new stockholders (if Bill incorporates CompU)? What other sources of capital could Bill use?

3. Would potential agency problems increase or decrease if Bill expands operations to other campuses? Would the agency problems be affected by whether he expands by licensing franchisees or by direct expansion, where CompU actually owns the businesses on other campuses and operates them as divisions of CompU?

4. What action or actions can you think of that might minimize agency problems for CompU as Bill expands beyond MSSU? Would going public in an IPO increase or decrease agency problems?

5. If CompU is successful, what kind of compensation program could Bill use to minimize agency problems?

6. If Bill hires someone whom he can train to manage one of the new divisions he plans to open at other campuses, would it matter whether or not that person understood something about financial management? If two people were applying for a job that would lead to a managerial position, should Bill be interested primarily in the person’s technical skills or in a combination of technical skills and a vision of how different functions within CompU fit together?

7. CompU is successful, and the before-tax earnings for the first year are $90,000. Calculate the tax on these earnings using Table 2.1.

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.

5. Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation?

6. What is block ownership? How does it affect corporate governance?

7. Briefly explain how regulatory agencies and legal systems affect corporate governance.

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