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AGENCY PROBLEMS and

ACCOUNTABILITY of CORPORATE
MANAGERS and SHAREHOLDERS
CHAPTER 5

INTRODUCTION

RELEVANT LEGAL ISSUES FOR


CORPORATE SOCIAL RESPONSIBILITY

Concern whether and to what extent


legal rules should mandate or restrict
mechanism of Corporate Governance.

It has no coherent meaning detached


from the specific mechanism by
which corporations are governed.

The legal issue is not whether the


corporation or any individual who
manage it should care about the society.

No question whether the parties of the


firm may contracts the to take
societys interest into account.
The question is the extend to which the law
should mandate contracts intended to produce
more socially-responsible governance or prohibit
that constraints socially-responsible
management

Corporate Social Responsibility is not


whether the managers should maximize
the firm profits, but rather in whose
interest they should manage.

Social Responsibility theorist argue


that market alone cannot adequately
discipline corporate conduct and
regulation of corporate conduct
doesnt redress all social harms
because:
These harms are difficult to detect
Regulation is difficult to design
Sanction maybe ineffective

ARGUMENT:

RESPONSE:

Empowering or
compelling managers
to run their
companies with a view
to societys interests
as well as those of
shareholders.

Societys interest are


not as inconsistent
with those of
shareholders.

An agency problem occurs when the interests of


stockholders, the board of directors and/or the
management of the company are not perfectly
aligned or when these entities conflict.
Executives who run the company on a day-today basis.
Shareholders who own stock.
Board of directors who oversee the
companys business development

Example
Executives of a corporation maybe
interested in achieving long-term growth of
the company.

AGENCY PROBLEM IN
CORPORATE

AGENCY THEORY
-supposition that explains the relationship
between the principal and Agents in business.
Can viewed as loosely defined contract between
the resource providers and resource controller.

PRINCIPAL AGENT
Patient Doctor
Shareholders Firm Manager
Defendant Defense Attorney

Cascading nature of Principal-Agent


Relations.

Principal

sharehold
ers

Board of
Directors Principal of:

executives

Managers

Auditors

PRINCIPAL AGENT SPECIFIC


ISSUES
DIVERSIFICATION vs. DIVIDENDS
MANAGERIAL OPPORTUNISM
POWER SUPREMACY VS. TECHNICAL
EXPERTISE
TRUST

DIVERSIFICATION vs. DIVIDENDS


-Control on how on available funds will be used or invested.

Product Diversification
Increased size, and relationship of size to
managerial compensation.
Reduction of managerial employment risk

Use of Free Cash Flow


Managers prefer to invest this funds in
additional product Diversification
Shareholders prefer the funds to as dividends
so they can control how the funds are invested.

MANAGERIAL OPPOTUNISM
Self -serving managers making decisions
that benefit them rather than the
company Owners or shareholders.
Shareholders return will not be
maximized to the fullest because of
unrelated diversification.

POWER SUPREMACY vs. TECHNICAL


EXPERTISE
Some of the corporate investors are just
putting their money with expectations of
dividend of the certain time.
Shareholders intention made them rely only on
the Expertise of the Agents and what is left to
them is supreme power over the corporation.
Agents doing the real things and principal
waiting for ultimate result.

TRUST
Shareholders have more trust than doubts
to the agents .
Failure in balance is one of the essential
component of managerial Opportunism.

IDENTIFIED AGENCY PROBLEM

ADVERSE SELECTION
AGENCY COST
CONFLICT OF INTEREST
LEGAL REQUIREMENTS VS.
OPPORTUNISTIC BEHAVIOR
SELF-INTERESTED BEHAVIOR

ADVERSE SELECTION
INSUFFICIENCY OF INFORMATION
The core concept of Adverse Selection
Agents present their working paper in rsum;
they discuss their qualifications in interviews,
principals screen the agents to be, most of the
screening process is actually anchored on the
information provided by the agents.
Through misrepresentation of information or
provide incomplete or half-cooked information.

AGENCY COSTS
Cautious principals will carry out some type of
monitoring activities to have reassurance that
decisions are most favorable from the point of view of
the principal.
These activities include reports, observation visits,
supervision and third party assurance like compliance
audit and external financial statement audit.
The most favorable amount of agency costs to be
done by shareholders is determined in a costbenefit context.

CONFLICT OF INTEREST
A corporations managers can or may have personal
objectives that compete with the owners objective of
maximization of shareholder wealth.
Shareholder wealth maximization could be subordinated
to an assortment of other managerial objectives.
As a result, current management may push for
diversification.
Managers can be encouraged to take action in
shareholders best interests through incentives,
constraints, punishments and other control mechanisms.
Moral danger- a problem if close monitoring is infeasible.
Shareholders must incur agency costs.

LEGAL REQUIREMENTS VS.


OPPORTUNISTIC BEHAVIOR
The culture of opportunism as manifested by
excessively paid executives and managers, the
ineffectiveness of principal-agent relationship and
the massive deficiency of the current agency
theoretical efforts and practices.
U.S. Congress enacted the Sarbanes-Oxley Act of
2002.
This law also affects the hierarchy of principalagent relationships.

SELF-INTERESTED BEHAVIOR
Agents have the capability to operate in their own selfinterest rather than in the best interests of the firm.
Absence of clear and compelling evidences that it is
the agents that is at fault or responsible and
consequently to be blamed or be crowned on the final
outcomes of the organization positive or negative.
Proof of self-interested executive and managerial
behavior includes the consumption of some corporate
resources in the form of stratospheric privileges,
unrelated diversification.

Proxy Voting
A Shareholder has no right to cast
votes by proxy in shareholders
meetings without special authority
given by the supposed voting
shareholders.

Proxy voting
In Corporate settings, proxy votings
use is normally limited to voting at
the annual meeting for directors, for
the sanctioning of acts of the
directors, for the increase or
decrease of capital, and for other
crucial amendments in the policies of
the organization.

Proxy voting
In proxy voting system, the absence of
the principal from the annual meeting of
business corporation, the proxy, being
given the authority, has the right to vote
in all instances, proxy is not having the
right to debate or otherwise participate
since this is outside of the authority
given. The right to argue is reserved only
if you are a voting shareholder of the
corporation.

Benefits of proxy voting


Routine Decisions
Governance
Issues on Anti-takeover

Routine Decisions generally vote


for uncontested director or trustee
nominees. These are example of
things that are not practically
sensible for all the stockholders to be
present and vote on the above
concern.

Governance Compliance with applicable


laws and regulations affecting the
organization.
Issues on Anti-takeover normally will
vote for proposals that necessitate
shareholders confirmation of anti-takeover
measures and proxy system provides a
swift and effective way of pilling up these
poison pills.

Proxy system is not without negative


implications. Proxies cannot modify
their decision on the deliberation
process; strength and weaknesses of
the arguments as well as counter
arguments are theoretically tested.

Derivative suit
is a law suit filed by a shareholder on behalf of
the corporation against a third party. Third party
is an insider of the corporation, directors and
other senior officers of the company. A
shareholder derivative in the sense that under
the corporation law, management which is
compose of directors, officers and other senior
manager are mandated to be responsible in
defending the corporation against the suit.

Specific Feature
The corporation code of the Philippines
shareholders are the owners of the corporation
but for practical reasons, they are not empowered
to manage the day-to-day operations and other
routinely concerns of the corporation. The
corporation against the parties that may cause or
is allegedly causing harm to the corporation.
Monetary or otherwise of a successful action will
be awarded to the corporation and not to the
individual shareholders.

Process
A strong and valid status before being permitted
to proceed with the action. The minimum of his
holdings in the corporation and the minimum
duration of his being a shareholder. In addition, to
initiate the action may be required to post a bond
or other fees to compensate whenever his action
is unsuccessful.

TAKEOVER

Corporate Takeover is the general


term referring of control of a firm
from one group of shareholders to
another group of shareholders

Types of takeover
Friendly takeover
Hostile takeover
o Tender offer
o Proxy fight
o Quietly purchasing enough stock in open
market

Reverse takeover
Tender offers

Friendly Takeover
Before a bidder company makes an
offer for another company, it usually
inform first the BOD of the company
to be taken over.
When the board thinks that
accepting the offer serves the
shareholders interest better , it then
recommends the said offer to be
accepted by the shareholders.

Hostile Takeover
Permits the acquirer to be
company to bypass the target
companys management if it is
uncooperative and unwilling to agree
to a merger or takeover.

Hostile takeover can be done in


several ways;
By tender offer whereby the acquiring
company makes a public offer the price of
which is way higher than the current market
price making it hard for existing shareholders
to resist.
By engaging to a proxy fight where by the
acquiring company persuades enough
shareholders , to replace the management
with new one.
Quietly purchasing enough stock in open
market, known as creeping

Reverse Takeover
Is a type of merger used by private
companies to become publicly-traded
without passing through initial public
offering.
Also known as reverse merger or
reverse IPO
With reverse merger or revere IPO, the
private company has saved itself from
paying expensive fees related to an initial
public offering.

Tender offers
Is a corporate finance term which
means a type of takeover proposal
that is public and open invitation,
usually coursed through media by
prospective acquirer to all
stockholders of publicly-traded
corporation which is the target
corporation

Financing a Takeover
-is an act of funding for the purpose
of obtaining control over a
corporation through the purchase of
stock or any other means ; the
process of providing capital for
someone to establish control of
another corporation

Debt Financing
by borrowing from a bank or raise the
funds needed through issuance of
bonds.
The acquisition which is financed by
debt is knwn as leveraged buyouts

Partial or full equity Conversion


This is done by giving the shareholders
the target company offers that include a
debt instrument in partial or in full
payment of shares.

Share Swap/All Share Deal


There will be no money involved
Bidder company issues its own new
shares to the shareholder of the
acquirer to be company.
The acquiring company will end up as
the majority shareholder and have the
control over the companys crucial
issues.

EXTERNAL FORCES
AFFECTING GOVERNANCE

1.
2.
3.
4.
5.
6.

Competitors
Financiers
Regulatory Agencies
Watchdogs
Predator companies
Information enhancer, providers and
gatekeeper
7. Investment banker

Competitors
To the eyes of the investors, the best
run business are the most attractive.
Competitors refer to corporations
and other business entities, private
or public offering the same product
or services that the company is
offering.

Financiers
Financiers is a term given to a person
or entity who manages routinely
huge amount of money. This person
or entity usually involved in the
activity of lending money, project
financing, large-scale investment or
large-scale management of money.

Regulatory Agencies
refers to a public authority or
government agency responsible for
exercising autonomous authority
over some area of corporate activity
in a regulatory or supervisory
capacity.

Watchdogs
refers to independent organizations
trying to police a particular industry
or corporate conduct to make certain
that the activities of these
companies are accordance with the
acceptable standards and existing
laws.

Predator Companies
refer to corporations that are always
on the watch and a waiting for a
chance to take-over a certain
company, be it via friendly or hostile
takeover.

Information enhancers,
Providers and Gatekeepers
Gatekeepers refers to independent
third party persons or entity whose
cooperation is important because
they have the capability to at least
deter, if not prevent misconducts of
corporations.

Investment Bankers
is an individual or entity which acts
as an agent for corporation issuing
securities. These entities also have a
large role in assisting interested
parties on mergers and acquisitions
as well as in debt restructuring.

Role of Investment
Banker
In time when corporation issues and sells new
securities to increase funds, the offering is called a
primary issue.
The agent responsible for finding buyers for these
securities for sale is called the investment banker.
Investment banker buys primary issue from
corporations and arranges immediate disposal of
these securities to the investors in public.
Generally, investment banking firms perform
three Functions: investigation, analysis and
research (origination). Underwriting (public
cash offerings) and distribution.

Origination (Investigation,
Analysis and Research)
Origination covers the secondary
operations of discovery, investigation, and
negotiation. Discovery is the finding of a
potential issue of securities; investigation is
the testing and analyzing of the investment
credit of the potential security issuer.

Underwriting (Public Cash Offerings)


Underwriting is an arrangement with an investment banker
whereby the investment banker agrees to buys the entire
issue ta set price.
It also refers to the guarantee by the investment banker
that the issuer company will receive a certain minimum
amount of cash for their new issued securities for sale.
can be completed in two ways,
first by negotiated underwriting which is the agreed and arranged
negotiation between the issuing company and the investment
banker.
Second is competitive bidding a setup in which the issuing
company awards the offering to the investment banker that bids
the highest price.

Distribution
Marketing the security issue is
another role of an investment banker.
Here, the investment banker acts as a
professional firm to distribute
securities efficiently for the
corporation.