QUESTION ONE
Why agency problem exists in corporations
Agency problem still exists in corporations because of the nature of companies. Corporations are legally separate entities from their shareholders. Thus, shareholders do not directly participate in running the affairs of corporations. In most corporations, there are so many shareholders that they cannot all participate in management. Instead, they employ executives or managers to manage the company on their behalf. Managers and shareholders have different interests thus leading to the agency problem. Executives may not always act in the best interest of shareholders.
Ways of mitigating agency problem
Board of Directors
An active and independent board of directors can mitigate the agency problem. The board is composed of experienced members and are responsible for the overall performance of the corporation (Mallin 169). The board has a representative of shareholders as well as the executive.
Pros: The board ensures that each decision of the corporation caters for the interest of all shareholders. Independent board members act in the nominating, remuneration and audit committee. This ensures that executives do not influence their compensation. Besides, it ensures transparency by enhancing external auditor’s independence. It is beneficial since members are professionals and bring in expertise to enhance the corporation’s performance.
Cons: The executives may ignore the inputs of non-executive directors. Furthermore, the corporation incurs additional expense in setting up the board and paying board members.
The market for corporate control
It is a takeover market where underperforming firms become attractive to potential acquirers. Investors acquire underperforming firms at lower prices and turns them around to improve their performances. This normally occurs when the board of directors fail.
Pros: The acquirers make fundamental changes in the management of the acquired corporations (Mallin 170). Thus, corporations’ executives would try to improve the performance of their firms to avoid hostile takeovers.
Cons: Executives can resist hostile through several defence actions know as poison pills. Shareholders may also lose control of the company to the acquirer.
Aligning interests of shareholders and executives
This involves creating incentives to ensure convergence of the interests of shareholders with that of management. Measures, in this case, include requiring executives to acquire a minimum shareholding in the company thus making them shareholders. Besides, performed-based remuneration of executives can align interests of the two groups. Compensation of executives should also be in the form of cash plus stock options.
Pros: as company executives work hard to maximise their pay, shareholders wealth is also maximised. It also reduces conflict of interests among the executives of the corporations since they also become shareholders.
Cons: It may lead to the dilution of control as managers acquire equity. Besides, managers may exercise their stock options and immediately sell the acquired stocks.
Most effective method
The board of directors is the most effective method of mitigating the agency problem. The board ensures the interests of shareholders as well those of executives are considered in all respects.
Qualities for successful governance
For it to work, the board composition must have a balance between executive and independent non-executive directors. Compensation/remuneration and audit committees must be composed of independent directors. Besides, the shareholders should have the power to elect or remove directors at the annual general meeting.
QUESTION TWO
Thomas Cook earned a total of $3,414,484 which included a base salary of $616,330, stock awards amounting to $1,231,719 and option awards totalling $601,622. He also earned $508,097 under non-equity incentive plan. On the other hand, James Green’s total compensation was $3,055,142. This included a base salary of $600,000, option awards totalling $505,134, stock awards worth $1,173,216 and $731,996 under the non-equity incentive plan (Investor.analogic.com). Thomas Cook offered a better value to shareholders than James Green although Cook’s compensation was higher. Greatbatch, headed by Cook, earned a total return on equity of 74.1% compared to the 11.3% of Analogic Corporation where James Green is the CEO.
Works cited
Investor.analogic.com,. "Analogic Corporation - Definitive Proxy Statement". N.p., 2016. Web. 3 Mar. 2016.
Mallin, Chris A. Corporate Governance. 4th ed. Oxford: Oxford University Press, 2013. Print.
