Reading 32: Corporate Governance-LOS c 习题精选 director, including, 2011, manager, purpose

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Session 9: Corporate Finance: Financing and Control Issues
Reading 32: Corporate Governance

LOS c: Discuss the conflicts that arise in agency relationships, including manager–shareholder conflicts and director–shareholder conflicts.

 

 

The purpose of the board of directors is to act as an intermediary between shareholders and management to assure that management is acting in shareholders’ best interest. Which of the following is NOT a factor that may cause directors to align more closely with managers than shareholders?

A) Directors are responsible for CEO succession planning.

B) Directors receive excessive compensation.

C) Directors are employed by financial institutions that lend money to the firm.

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Succession planning for the CEO is one of the duties of the board of directors, and should not cause directors to align with management over shareholders. Factors that could cause directors to align more closely with management include:

• Lack of independence (i.e. family relationships, prior employment, or existing business relationships).
• Interlinked boards.
• Directors are overcompensated.
  

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A principal-agent problem may exist between:

A) shareholders and directors.

B) managers and directors.

C) regulators and directors.

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An agency relationship exists when an individual (the agent) acts on behalf of another individual (the principal). Such a relationship creates the potential for a principal-agent problem where the agent may act for his own well being rather than that of a principal. The key test of whether a principal-agent problem may exist is if one party is responsible for acting in the best interest of the other. Of the answer choices given, directors are responsible for acting in the best interests of shareholders.

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Corporate governance systems are primarily concerned with potential principal-agent problems between:

A) directors and shareholders.

B) managers and directors.

C) managers and creditors.

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Corporate governance systems attempt to minimize or eliminate any potential agent problems that may arise between two groups: (1) directors and shareholders and (2) managers and shareholders

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Kimi Hatcher is a consultant for Druson Corporate Consultants. Hatcher recently evaluated the management team at Burnett Television Productions and wrote a report of her observations. 

Observation 1:	Over 65% of senior management compensation is in the form of executive stock options. Management tends to aggressively take on risky projects that will generate large profits if the projects succeed.
Observation 2:	Management frequently uses retained profits to purchase potential competitors as well as business unrelated to television production in an effort to diversify their revenue base.
Observation 3:	Management makes a practice of setting aside provisions for loss contingencies.

A Burnett shareholder that is reading the report is particularly concerned about ways that management may act for their own best interests rather than those of shareholders. Which of observations in Hatcher’s report should alarm the shareholder?

A) All of the observations.

B) Observations 1 and 2 only.

C) Observation 1 only.

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While managers are hired to make decisions to maximize shareholder wealth, they may make decisions to maximize their own wealth. Examples of ways that management may act for their own interests include expanding the size of the firm, which can increase the manager’s job security and power, and managers compensated largely by stock option taking large risks that will generate huge payoffs for the managers if successful, but cost the managers nothing if they do not. Note that setting aside provisions for loss contingencies is considered a conservative accounting practice.

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Which of the following scenarios is NOT an example of a principal-agent problem?

A) Top management is awarded large amounts of executive stock options.

B) A board member also serves as a consultant to the company.

C) A senior manager also serves as a director on the board of another company.

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A senior manager may serve on the board of another company so long as there are no other circumstances that may compromise objectivity. For example, problems arise if the boards of two companies are “interlinked” by way of managers of Company A serving on the board of Company B, and managers of Company B serving on the board of Company A.

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The principal-agent problem can best be described as:

A) the agent may act for the well being of management rather than that of the stakeholders.

B) the agent may act for the well being of the principal rather than that of the stakeholders.

C) the agent may act for his own well being rather than that of the principal.

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In a principal-agent relationship, one party (the agent) acts on behalf of another party (the principal). A principal-agent problem arises when the agent places his own interests ahead of the principal.

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Jill Tangeman and Lawrence Winkelman are shareholders for Hilliard Electric Components, Inc. (HECI). Tangeman and Winkelman are concerned about potential conflicts of interest that may affect them as shareholders of HECI and decide to draft a letter to various HECI decision makers to ask them what they are doing to eliminate or reduce potential conflicts of interest.

The basic premise of Tangeman and Winkelman’s letter is that corporate governance systems should focus on two potential areas where decision makers may not act in shareholders best interests: conflicts between managers and shareholders, and conflicts between directors and shareholders.

Winkelman states in the letter than he is concerned about executive compensation. “Having too much executive wealth concentrated in employee stock options can lead to managers avoiding potentially risky projects that would actually maximize wealth for shareholders.” Tangeman adds her own comment: “The primary responsibility of the board of directors is to assure that shareholders’ interests are balanced with those of management when negotiating on issues such as compensation.” When the letter is complete, both sign it as shareholders in the company and mail out 12 copies.

The assertion made by Tangeman and Winkelman about the focus of corporate governance systems is:

A) invalid, and only Tangeman makes a correct statement in the letter.

B) valid, and only Winkelman makes a correct statement in the letter.

C) valid, and neither Winkelman or Tangeman make a correct statement in the letter.

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The assertion made by Tangeman and Winkelman is valid – one of the two main objectives of corporate governance is to eliminate or reduce conflicts of interest. The two primary areas for potential conflicts of interest in a corporation are conflicts between shareholders and management and conflicts between directors and shareholders.

Winkelman’s statement is incorrect. Executive compensation in the form of large amounts of stock options can cause managers to take on too much risk as the asymmetric payoff of those options means that managers can reap huge rewards if the risks pay off, but will not share in the losses if the risky projects fail. Note that managers taking too little risk is also a concern, but taking too little risk is a symptom of managers holding too much stock – not stock options. If the manager has the bulk of their wealth tied to company stock, the manager may want to avoid risky projects to protect the value of the stock even though the risky projects may do a better job of maximizing value for the firm’s shareholders.

Tangeman’s statement is incorrect in two respects. The most important roles for the board of directors is to institute long-term strategic objectives for the company and institute corporate values that will insure that business is conducted in an ethical and fair manner. Also – the board should not “balance shareholder and management needs” when negotiating with management in areas such as compensation. The board needs to determine management compensation with shareholders’ best interest as their sole consideration.