Mini Case: 13 – 1
Chapter 13
Corporate Governance
ANSWERS TO END-OF-CHAPTER QUESTIONS
13-1 a. An agency relationship arises whenever one or more individuals, the principals, hire
another individual, the agent, to perform some service and then delegate decision–
making authority to that agent. Primary agency relationships exist between (1)
stockholders and managers, and (2) between debtholders and stockholders.
b. Agency costs include all costs borne by shareholders to encourage managers to
maximize a firm’s stock price rather than act in their own self-interests. The three
wealth.
c. An agency problem arises whenever a manager of a firm owns less than 100 percent
of the firm’s common stock, creating a potential conflict of interest called an agency
conflict. The fact that the manager will neither gain all the benefits of the wealth
debt, and they have a claim on the firm’s assets in the event of bankruptcy. However,
stockholders have control (through managers) of decisions that affect the riskiness of
the firm.
d. Managerial entrenchment occurs when a company has such a weak board of directors
Mini Case: 13 – 2
e. Targeted share repurchases, also known as greenmail, occur when a company buys
than a specified amount of stock.
f. A stock option allows its owner to purchase a share of stock at a fixed price, called
the strike price, no matter what the actual price of the stock is. Stock options always
have an expiration date, after which they cannot be exercised. A restricted stock
the perks they consume, such as lavish offices, vacations, golf club memberships, etc. If
the owner/manager is the only manager, then the owner/manager bears full cost of the
perks. But if the owner/manager only owns part of the company, the owner/manager
reaps all the benefits of the perks but the cost is shared by the outside shareholders.
Potential investors know this might happen, so they pay less for a minority interest in a
little or by a lot, the borrower doesn’t get anything. So borrowers have an incentive to
take on riskier projects. Borrowers also might take on additional debt. Lenders anticipate
this, and charge a higher interest rate.
13-4 Entrenched managers consume too many perquisites, such as lavish offices, excessive
Mini Case: 13 – 3
MINI CASE
Suppose you decide (like Steve Jobs and Mark Zuckerberg did) 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 market 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, 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.
a. 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.
Answer: An agency relationship arises whenever one or more individuals, called principals,
(1) hires another individual or organization, called an agent, to perform some service
in the form of increased personal wealth, more leisure, or perquisites.
b. If you expanded, and hired additional people to help you, might that give rise to
agency problems?
Mini Case: 13 – 4
c. 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?
d. Suppose your company raises funds from outside lenders. What type of agency
costs might occur? How might lenders mitigate the agency costs?
e. Suppose your company is very successful and you cash out most of your stock
and turn the company over to an elected board of directors. Neither you nor any
other stockholders own a controlling interest (this is the situation at most public
companies). List six potential managerial behaviors that can harm a firm’s
value.
Answer: Managers might:
1. Expend too little time and effort.
2. Consume too many nonpecuniary benefits.
Mini Case: 13 – 5
f. The managers at KFS have heard that corporate governance can affect
shareholder value. What is corporate governance? List five corporate
governance provisions that are internal to a firm and are under its control.
g. What characteristics of the board of directors usually lead to effective corporate
governance?
.
h. List three provisions in the corporate charter that affect takeovers.
i. Briefly describe the use of stock options in a compensation plan. What are some
potential problems with stock options as a form of compensation?
Mini Case: 13 – 6
website, in whole or in part.
j. What is block ownership? How does it affect corporate governance?
Answer: Block ownership occurs when an outside investor owns large amount (i.e., block) of