Agency Cost Problem between Controlling Minority Shareholders and Non-Controlling Shareholders - Assignment Example

Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: QUESTION ONE: Agency cost problem is between controlling minority shareholders and non-controlling shareholders rather than between the management and shareholders. Many firms globally estimates the agency cost resulting from controlling minority shareholders and non-controlling shareholders who own voting rights but less cash flow rights. Clay (2007), Shows that up to 310 companies in Sweden employ CRM structures operate their firms where the cost of controlling minority shareholders was estimated at 6-25%. Family controlling minority shareholders are associated with large amounts of discounts on the value of the firm. CRM seems to depend on the control from non-controlling shareholders (Blair, n.d). According to Clay (2007), controlling minority shareholders hangs on the opinions made by non-controlling shareholders. The firm employing CRM structures are less likely to be overtaken than other types of firms. Many countries such as Djankov, Barca and La Porta, firms have large amount of controlling shareholders as compared to Belie and Means (1934), where firms are widely owned by managers. Such shareholders in La Porta often owned substantial rights regarding control of the organization such as voting rights rather than cash flow rights. Such shareholders are referred to as controlling minority shareholders. Swedish Telkom and electric companies have evaluated the consequences of employing CRM structures in their firms which have never received more attention. According to Chan-Lau (2001), existence of information symmetry among shareholders and executive directors pose a moral hazard to the corporation. Agency cost in CRM may be caused by contracting cost and divergence of control. According to Michael Jensen, a senior lecturer University of Harvard, business department, there are various actors in a corporation and different fields that can incur agency cost. The stake of agency cost can result from a manager whose interest in a corporation is different from those stated bi its memorandum and articles of association (Cronqvist & Nilsson, 2003). According to a study done in many firms in US, the results showed that about 78% of agency cost problems in corporations are directly linked to manager’s operations. Directors of the firm may concentrate to increase the size of the firm at the expense of its profitability. They may not fire employees in the firm whose actions are not contrary to objectives of the firm at the expense of being their own friends. Controlling minority shareholders framework employs dual class share or other major corporate control measures to entrench themselves from pressure from corporate mechanisms. Controlling minority shareholders have large powers to expropriate non- controlling shareholders, a consequence that is only restricted by law and by CMS financial incentives that restricts them from engaging in explorative activities (Cronqvist & Nilsson, 2003). Burkart (2003) argues that if firms continue to assume CRM structures, then they will face tradeoff consequences between value enhancing practices and extraction of benefits from the private sector. Bebchuk (2004), argues that CRM structures reap high private benefits since it only concentrates on internalizing minority corporate valuation of the consequences. Thus the agency cost as a result of employing CRM structures are increasing the chances of extracting private benefits within an organization. This proofs the argument that, in many nations the agency cost problem is between controlling minority shareholders and non-controlling shareholders rather than between the management and shareholders. In European market, control of minority shareholders framework has been scrutinized due to political pressure. In Asia, the government is paying more attention on the needs of non- controlling shareholder’s rights. Trends are formulated by many governments globally that aims at regulating CRM structures and mechanisms (Hirschey, John & Makhija, 2003). In early 1997, the government of Taiwan government approved a law that regards stock pyramids and cross shareholding. The agency cost estimated in Sweden associated with controlling family CRMs is 6-25% of firm’s value. They are legal framework that are associated with largest reduce I value of the firm. Returns from a given investment is lower as compared to firms concentrated on the hands of managers. Burkart (2003), Argues that CRM benefits seems to be associated with benefits that the companies do not engage themselves in. The scope of control is concentrated on the voting rights that are held up by minority shareholders. Burkart (2003), Argues that CRM framework in many firms globally, has a larger potential to create big agency cost. It combines the problem of the firm with those of insiders who have interest on the performance of the firm. According to Jensen (2004), controlling minority shareholders framework can distort decision making process regarding the choice of projects, the size of the firm and how control mechanism should be operated in a firm. It reveals out that when significant amount of private benefits is expected by shareholders, the insider will have more control for the firm regardless of its performance. This argument suggests that CRMs are associated with agency cost problems in many organizations and firms globally (Tufano, 1998). QUESTION TWO During the past years, stock options have been used as a compensation mechanism to many employees. Past studies have shown clearly that stock option mechanism is a leading strategy employed by many firms to compensate top management and employees (Hoguet, 2006). In United States of America, stock grants is tied to performance by top management or employees. Some Decades back, many Japanese firms were restricted from using stock grants as means of compensating their employees (Hoguet, 2006). Later in 1997, the Japanese commercial law was amended to allow firms to use stock options as means of compensating top management and employees. What then is the benefit? Stock options are form of equity compensation by firms and corporation to top management and their employees for anticipating high performance. It gives the person a right to buy quoted stocks at a price agreed upon (Hoguet, 2006). Stocks are not important elements although tied to performance because they cannot trade in secondary market, they cannot be transferred to any other individual. An estimate of nine million people hold stocks as means of linking their own interest with those of the company. This survey depicts up to 30% lower value than the previous sensors done by financial analyst. According to Hettihewa & Wright (2010), changes in rules and regulations regarding accounting reporting techniques and measures contributed to change in option holding. Stock options offers right to buy the shares of the company at a fixed rates. This implies that the employee will not only benefit from employee compensation program but also from price benefits (Hettihewa & Wright, 2010). Top managers and employees receiving such grants expects to purchase company’s stocks at a cheaper price and resell them at a profit. Many companies strives to employ motivational programs that will see their employees increase the level of their performance. Stock option plans is a major way of motivating employees. It is a common way for companies to share their own ownership with employees. Better performance within the management team is one way of achieving high levels of success by the company. High levels of profitability depicts high dividends payout to shareholders of the company. It motivates the employee to be loyal to the organization. Employee loyalty is gained through achieving better working conditions such as compensatory programs for their performance (Kato, Lemmon, Luo & Schallheim, 2005). Options therefore is not a pave way where existing workers sell their stocks, it is unsuitable for small and medium term enterprises which are anticipating for growth. They cannot by effective in small companies and startups which aim at entering in to new markets. Practically, when companies considers to design a good stock program, then they should know who and how is it appropriate to the target subject. A problem will always occur when a company offers too many options to existing employees at the expense of future employees. All employees and top management need to be involved in ownership rights of the company (Wilson, 2011). The management team should not only concentrate on rewarding the top executive but also subordinate staff whose efforts have moved the company towards achieving success. Stock options in a firm give an employee a chance to benefit from increase in the value of the company. This is made possible by allowing workers the right to buy the shares of the company at a specific quoted price. Stock options should be issued to the right employees based on performance. It is an aspect where performance of employees and top management is rewarded (Pelucio-Grecco, Grecco & Lima, 2014). However, some companies have misused the right to give stock options to employees. Stock options awards is biased. The main idea stock options is to reward an employee and shareholders. Company makes options available to their employees and top management because they want to keep them loyal (McAnally, Srivastava & Weaver, 2008). According to the journal, “employee motivation” it argues that the aspect of motivation gives an employee internal force to accomplish his/ her tasks. They also want their employees to feel as part of the company by owning their shares. They seek to employ workers whose compensation goes beyond their salary. Practically, stock options are offered by companies and corporations to their employees to compensate them for good performance. It induces positive culture among the employees of the company Abell, Samuels & Cranna, 1994). Stock options gives an employee or top executive the right but not an obligation to own company shares for a specific period of time at a given quoted price. Top management are motivated to carry out fiduciary duties within the organization. Managers and company directors have the obligation to formulate effective policies that are geared towards improving the activities of the company by avoiding conflicts of interest with shareholders of the firm (McAnally, Srivastava & Weaver, 2008). The executive body has the function of planning, organizing and directing resources of the company towards maximizing the wealth of shareholders. In some companies, employees are given rights to acquire company stocks at a cheaper price that other shareholders to keep them loyal to the company. Employees are motivated when the type of work done through their effort is appreciated (Ezzamel, 2005). According to research done by Michael, senior lecturer university of Harvard, business department, employee motivation is an essential program that has enabled many companies to anticipate high levels of growth. High production and quality services to target customers arises when employees and managers are motivated by the owners of the company. The research shows that companies who engage their efforts in employee motivational programs perform better than those who do not (Pirchegger, n.d). Most firms in United States of America offer stock compensation programs to their workers. In 1997, Japan firms were restricted from offering stock options to their employees as a way of compensation. However, later in the same year, the regulation was removed and firms were allowed to offer options in order compensate their employees. Managers act on behalf of shareholders through ensuring maximization of shareholder’s wealth. They have fiduciary duty to act contrary to duties and responsibilities that are geared towards promoting the activities of the firm (Oyer & Schaefer, n.d). According to Susan, a senior manager in Offshore Industries in Asia, being a manger does not only constitute payment and salary, but how best you carry out your management functions towards achieving the goals and objectives of the firm. On the other hand, misuse of stock option right forms a strong basis for failure in the company. Stock options rewarded to top management at the expense of minority employees may discourage the motive to work harder. Specific employees with awesome performance should be given the right to buy stock options of the company at a specific quoted price thus making them feel part of the company. Reference: Abell, P., Samuels, J., & Cranna, M. (1994). Mergers, motivation and directors' remuneration. London: Centre for Economic Performance. Bebchuk. (2004). Managing and control of minority sharehilders in the firm. Mexico: Daily press. Blair, M. Post-Enron Reflections on Comparative Corporate Governance. SSRN Journal. doi:10.2139/ssrn.316663 Burkart. (2003). Shareholders Control . Harvard: Daily Adventure. Chan-Lau, J. (2001). The impact of corporate governance structures on the agency cost of debt. [Washington, D.C.]: International Monetary Fund. Clare. (2005). Controlling Mnority Shareholders. Chicago: Oxford press. Clay. (2007). Minority shareholderr rights and control. Daily Business Analysis , 12-45. Cronqvist, H., & Nilsson, M. (2003). Agency Costs of Controlling Minority Shareholders. The Journal Of Financial And Quantitative Analysis, 38(4), 695. doi:10.2307/4126740 Ezzamel, M. (2005). Governance, directors and boards. Cheltenham, UK: E. Elgar. Hettihewa, S., & Wright, C. (2010). Socio-Economic Differences and Deployment of the LDC Micro-Finance Bottom-up Approach in DCs. Journal Of Electronic Commerce In Organizations, 8(2), 41-53. doi:10.4018/jeco.2010040104 Hirschey, M., John, K., & Makhija, A. (2003). Corporate governance and finance. Amsterdam: JAI. Hoguet, G. (2006). Earnings estimates in emerging markets—an update. Emerging Markets Review, 7(3), 213-227. doi:10.1016/j.ememar.2006.06.002 Jensen. (2004). Shareholders of the firm and thier control. chicago : Oxford press. Kato, H., Lemmon, M., Luo, M., & Schallheim, J. (2005). An empirical examination of the costs and benefits of executive stock options: Evidence from Japan. Journal Of Financial Economics, 78(2), 435-461. doi:10.1016/j.jfineco.2004.09.001 McAnally, M., Srivastava, A., & Weaver, C. (2008). Executive Stock Options, Missed Earnings Targets, and Earnings Management. The Accounting Review, 83(1), 185-216. doi:10.2308/accr.2008.83.1.185 Oyer, P., & Schaefer, S. (n.d). A Comparison of Options, Restricted Stock, and Cash for Employee Compensation. SSRN Journal. doi:10.2139/ssrn.441860 Pelucio-Grecco, M., Geron, C., Grecco, G., & Lima, J. (2014). The effect of IFRS on earnings management in Brazilian non-financial public companies. Emerging Markets Review, 21, 42-66. doi:10.1016/j.ememar.2014.07.001 Pirchegger, B. (n.d). Costs and Benefits from Repricing Employee Stock Options. SSRN Journal. doi:10.2139/ssrn.315720 Tufano, P. (1998). Agency Costs of Corporate Risk Management. Financial Management, 27(1), 67. doi:10.2307/3666152 Wilson, M. (2011). Earnings Management in Australian Corporations. Australian Accounting Review, 21(3), 205-221. doi:10.1111/j.1835-2561.2011.00138.x Read More