Week 7 & 8 Discussion Boards - Please see attached

Week 7: "Financial Planning and Agency Conflicts"

• Week 8: "Distributions to Shareholders"

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Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. MINI CASE Suppose you decide (as did Steve Jobs and Mark Zuckerberg) 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, and 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. b. If you expanded and hired additional people to help you, might that give rise to agency problems? 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. f. 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? j. What is block ownership? How does it affect corporate governance? k. Briefly explain how regulatory agencies and legal systems affect corporate governance. 1 One of the first, and most important, papers in finance and economics to address agency conflicts was written by Michael Jensen and William Meckling and entitled \"Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,\" Journal of Financial Economics, Vol. 3, 1976, pp. 305-360. 2 Notice that we said both legal and ethical actions. The accounting frauds perpetrated by Enron, WorldCom, and others that were uncovered in 2002 raised stock prices in the short run, but only because investors were misled about the companies' financial positions. Then, for example, when Enron finally revealed the correct financial information, the stocks tanked. Investors who bought shares based on the fraudulent financial statements lost tens of billions of dollars. Releasing false financial statements is illegal. Aggressive earnings management and the use of misleading accounting tricks to pump up reported earnings is unethical, and executives can go to jail as a result of their shenanigans. When we speak of taking actions to maximize stock prices, we mean making operational or financial changes designed to maximize intrinsic stock value, not fooling investors with false or misleading financial reports. 3 We have adapted this framework from the one provided by Stuart L. Gillan, \"Recent Developments in Corporate Governance: An Overview,\" Journal of Corporate Finance, June 2006, pp. 381-402. Gillan provides an excellent discussion of the issues associated with corporate governance, and we highly recommend this article to the reader who is interested in an expanded discussion of the issues in this section. 4 There are a few exceptions to this rule. For example, some states have laws allowing the board to consider the interests of other stakeholders, such as employees and members of the community. 5 There is currently (early 2012) a movement under way to allow shareholders to nominate candidates for the board, but only time will tell whether this movement is successful. 6 See Diane Del Guercio, Laura Seery, and Tracie Woidtke, \"Do Boards Pay Attention When Institutional Investor Activists 'Just Vote No'?\" Journal of Financial Economics, October 2008, pp. 84-103. 7 See I. E. Brick, O. Palmon, and J. Wald, \"CEO Compensation, Director Compensation, and Firm Performance: Evidence of Cronyism?\" Journal of Corporate Finance, June 2006, pp. 403-423. 8 Some states have laws that go further than others to protect management. This is one reason that many companies are incorporated in manager-friendly Delaware. Some companies have even shifted their state of incorporation to Delaware because their managers felt that a hostile takeover attempt was likely. Note that a \"shareholder-friendly charter\" could and would waive the company's right to strong anti-takeover protection, even if the state allowed it. 9 Someone can, under the law, acquire up to 5% of a firm's stock without announcing the acquisition. Once the 5% limit has been hit, the acquirer has 10 days to \"announce\" the acquisition by filing Schedule 13D with the SEC. Schedule 13D reports not only the acquirer's number of shares but also his or her intentions, such as a passive investment or a takeover. These reports are monitored closely, so as soon as one is filed, management is alerted to the possibility of an imminent takeover. 10 Several academic studies show that option-based compensation leads to a greater likelihood of earnings restatements (which means having to refile financial statements with the SEC because there was a material error) and outright fraud. See A. Agrawal and S. Chadha, \"Corporate Governance and Accounting Scandals,\" Journal of Law and Economics, 2006, pp. 371-406; N. Burns and S. Kedia, \"The Impact of Performance-Based Compensation on Misreporting,\" Journal of Financial Economics, January 2006, pp. 35-67; and D. J. Denis, P. Hanouna, and A. Sarin, \"Is There a Dark Side to Incentive Compensation?\" Journal of Corporate Finance, June 2006, pp. 467-488. 11 For a discussion of EVA, see Al Ehrbar, EVA: The Real Key to Creating Wealth (New York: John Wiley & Sons, 1998); and Pamela P. Peterson and David R. Peterson, Company Performance and Measures of Value Added (The Research Foundation of the Institute of Chartered Financial Analysts, 1996). 12 For example, see Jonathan M. Karpoff, D. Scott Lee, and Gerald S. Martin, \"The Cost to Firms of Cooking the Books,\" Journal of Financial and Quantitative Analysis, September 2008, pp. 581-612. 13 For example, see R. La Porta, F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, \"Legal Determinants of External Finance,\" Journal of Finance, January 1997, pp. 1131-1150; Hazem Daouk, Charles M. C. Lee, and David Ng, \"Capital Market Governance: How Do Security Laws Affect Market Performance?\" Journal of Corporate Finance, June 2006, pp. 560-593; and Li Jin and Stewart C. Myers, \"R2 Around the World: New Theory and New Tests,\" Journal of Financial Economics, February 2006, pp. 257-292. 14 See M. De Fond and C. Park, \"The Effect of Competition on CEO Turnover,\" Journal of Accounting and Economics, Vol. 27, 1999, pp. 35-56; and T. Fee and C. Hadlock, \"Management Turnover and Product Market Competition: Empirical Evidence from the U.S. Newspaper Industry,\" Journal of Business, April 2000, pp. 205-243. 15 See R. Parrino, \"CEO Turnover and Outside Succession: A Cross-Sectional Analysis,\" Journal of Financial Economics, Vol. 46, 1997, pp. 165-197. 16 See U. Malmendier and G. A. Tate, \"Superstar CEOs,\" Quarterly Journal of Economics, November 2009, pp. 1593-1638. 17 For example, see D. B. Farber, \"Restoring Trust after Fraud: Does Corporate Governance Matter?\" Accounting Review, April 2005, pp. 539-561; and Stephen P. Ferris, Tomas Jandik, Robert M. Lawless, and Anil Makhija, \"Derivative Lawsuits as a Corporate Governance Mechanism: Empirical Evidence on Board Changes Surrounding Filings,\" Journal of Financial and Quantitative Analysis, March 2007, pp. 143-166. 18 See Gary Laufman, \"To Have and Have Not,\" CFO, March 1998, pp. 58-66. 19 Our description is simplified. Technically, the stock would be placed in a suspense account and then be allocated to employees as the debt is repaid. 20 We assumed that the company used the $50 million paid to it by the ESOP to repurchase common stock and thus to increase its de facto debt. It could have used the $50 million to retire debt, in which case its true debt ratio would remain unchanged, or it could have used the money to support an expansion. 21 See Daniel Eisenberg, \"No ESOP Fable,\" Time, May 10, 1999, p. 95. FIN 534 Discussion Board Week 7 Week 7: "Financial Planning and Agency Conflicts" Please respond to the following: 1. From the scenario, cite your forecasting conclusions that support TFC's decision to expand to the West Coast market. Speculate as to whether or not the agency conflict discussed in the scenario could become a roadblock to your conclusions. Provide a rationale for your response. 2. From the mini case, recommend two (2) desired characteristics of a board of dire ctors. Provide support for your response, citing the ways in which these characteris tics usually lead to effective corporate governance. Week 8: "Distributions to Shareholders" Please respond to the following: 1. From the eActivity, contrast the differences between a stock dividend and a stock split. Imagine that you are a stockholder in a company. Determine whether you would prefer to see the company that you researched declare a 100% stock dividend or declare a 2for1 split. Provide support for your answer with one (1) realworld example of your preference. 2. From the scenario, examine the dividend rate that TFC is paying in order to determine if the company should receive a rate adjustment. Suggest whether TFC's dividends should either (1) stay the same; (2) be increased; (3) or go down. Provide a rationale for your response. 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