Omnitech is an up and coming high tech startup manufacturer that hired Igor Valuchev as its chief executive officer. Valuchev came from a high tech background running another established firm providing value-added technology products to moderate-sized firms. The board of Omnitech believed Valuchev had the right experience to lead the firm and develop new products. Despite the fragile startup position of the firm, the board could not attract Valuchev with salary alone, but could only attract him by offering stock options and a bonus tied to performance. Valuchev's reputation demanded a fairly hefty salary and perquisite package. As Valuchev took the reins he pushed the company to achieve a strong earnings stream and developed a culture stressing the importance of exceeding company financial benchmarks. Although the company benefited from this culture by meeting short-term goals, the company sacrificed future opportunities to expand with related products. Valuchev had a clause in his contract that if the company met certain goals he would receive a stock option award and bonus based on a negotiated schedule. In the meantime, Valuchev's predecessor firm took advantage of the new opportunities to expand into the products passed up by Omnitech. The opportunity turned into a lucrative investment for Valuchev's old firm resulting in returns in excess of 32%. Valuchev believed it more important first to build a culture of meeting goals before jumping into new ventures. Besides his own award of stock options, Valuchev rewarded the rest of his executive team with stock options to align key management's goals with those of the shareholders. Awarding options compensated the key managers by aligning their performance with the performance of the firm. Since Valuchev believed it did not make sense to go to the board for each award, he turned the project over to his chief financial officer. Valuchev discussed what he wanted to do with the board chair. At the following board meeting, Valuchev and the board chairman together announced they had executed the stock awards to the key management group. Apart from his other responsibilities, Cleat Sure, the chief financial officer, had the option agreements prepared for the top five key officers. Sure decided to find a date during the last 90 days where the stock price dipped to its lowest point to date the option agreements. This strategy almost assured the management team would receive options in the money at the time of the award.

Use the scenario in this unit's lesson to discuss the following issue:

How are securities markets affected by agency problems? What measures should regulators take to prevent abuses?

Consider oftentimes management owning significant percentages of shares in the firm are one and the same as the owners. What problems do management ownership present related to agency problems?