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Question: Manager and shareholders may not always have the same objectives; Using agency theory, discuss the potential conflict from this principal-agent relationship.

25 Oct 2022,8:37 PM

 

  1. Your business expects to receive a payment of £9000 one year from now. What is the present value of this payment assuming a discount rate of 12%?

 

  1. £10,080

  2. £8,036

  3. £7,500

  4. £1,080

 

  1. If interest rates fall, what will be the effect on the price of a 8% treasury bill?

 

  1. Price will rise

  2. Price will fall

  3. There will be no impact on the price

  4. Price will remain the same, but the interest received will rise

 

  1. The principal agent problem can be exaggerated by:

 

         a.     Increasing corporate governance regulation

         b.     Symmetric information

         c.     Efficient markets

         d.     Managerial compensation based on stock price

 

  1. A stocks intrinsic value (V0):

 

  1. Is the combined value of all its expected future cash flows

  2. Always is equal to the stock price

  3. Always differs from the stock price

  4. Remains the same over time

 

  1. Market efficiency is reduced by:

    1. Increased access to data

    2. Asymmetric information

    3. Improved monitoring

    4. Enhanced data analytics

 

 

 

Use the following expectations on Stocks X and Y to answer the following five questions

 

 

Probability

Stock X

Stock Y

Bear Market

0.2

2%

12%

Normal Market

0.4

5%

10%

Bull Market

0.4

18%

6%

 

  1. What is the expected return of Stock X?

 

a.       10%

  1. 4%

  2. 3%

  3. 6%

 

  1. What is the expected return of Stock Y?

 

a.     10%

b.     8%

  1. 12%

  2. 8%

 

 

  1. What is the standard deviation of return on Stocks X?

 

      10.6%

  1. 5%

  2. 7%

  3. 7%

 

 

  1. What is the standard deviation of return on Stocks Y?

 

  1. 6%

     8.5%

  1. 7%

  2. 7%

 

 

  1. Assume that of your £1,000 portfolio, you invest £400 in Stock X and £600 in Stock Y. What is the expected return on your portfolio?

 

a.     6%

b.     8%

c.     10%

d.     12%

 

For the following two questions refer to the information below:

 

The management of FDM Plc. are currently evaluating an investment in products costing £12,000.  Anticipated net cash inflows are over four years with £4,000 received at the end of year 1, 2, 3 and 4.

 

  1. If the discount rate is 8%, calculate the projects Net Present Value (NPV).

 

a.     - £1,692

b.     - £692

c.     £692

d.     £1,692

 

  1. If the discount rate was 10% and applying the NPV rule:

 

a.     The project should be accepted

b.     The project should be rejected

c.     More information is required

d.     The project has a zero NPV

 

  1. You are valuing a project that is expected to earn a one-time cash flow of £400m in four years. You estimate a discount rate of 8%. What is the present value of this cash flow?

 

a.     £544m

b.     £94m

c.     £294m

d.     £370m

 

 

  1. An investment offers a perpetual cash flow of £650 every year. The required return on the investment is 7%. The PV of the investment is?

 

a.     £928

b.     £9,286

c.     £86

d.     £28

 

  1. Suppose a perpetual bond has been issued at par £1000 with coupon interest payment £60.00 Now 10 years after issue the required rate falls to 4%. What is the current value / price of this bond?

 

  1. £1,000

  2. £35

  3. £1400

  4. £70

 

For the following four questions refer to the information below:

 

 

E(R)

σ

Asset A

9%

3%

Asset B

14%

7%

 

 

 

 

  1. Calculate the expected return of the two-asset portfolio to an investor with 40% invested in Asset A and 60% invested in Asset B

 

a.     7%

b.     11%

c.     14%

d.     18%

 

  1. Calculate the portfolios risk. The covariance between the two assets is 5.

 

a.     21%

b.     11%

c.     5%

d.     2%

 

 

  1. Calculate the portfolios correlation

 

a.     0

b.     - 0.24

c.     0.6

d.     0.28

 

  1. If instead the investor invested 75% of his wealth in Asset B, the portfolio expected return would:

 

a.     Increase

b.     Decrease

c.     Not change

d.     Increase or decrease

 

  1. FDM ltd issues a three-year bond with a 12% coupon rate and interest repayable annually. The bond is priced at its face value of £100 and the market rate of interest is 8%. What is its current value?

 

a.     £97

b.     £110

c.     £70

d.     £800

 

1.

  • Compare and contrast four different types of business structures.             (5 marks)

 

 

(b)  Manager and shareholders may not always have the same objectives. Using agency theory, discuss the potential conflict from this principal-agent relationship.

 (8 marks)

 

  • Provide a detailed account of how ‘superstar’ firms have come to dominate the world economy and how Covid-19 has impacted them.                  (12 marks)

 

Total 25 marks

 

 

    • Explain what you understand by Aggregate Demand Consumer and what will cause the Aggregate Demand curve to shift.                    (5 marks)

 

  • The global economy is expected to grow 6.0% in 2021. Discuss the key factors that will affect global growth predictions for 2022.                                          (8 marks)

 

  • “Business leaders are acknowledging that they must take sustainability factors into account in order to achieve long-term financial success and ensure the viability of their business model” Discuss.                                                               (12 marks)

 

Total 25 Marks

 

  1.  

(a)  What are rating agencies and are they regulated?                                        (5 marks)

 

(b)  The COVID-19 pandemic has had far reaching impacts on business and society around the world. Consider top governance trends for 2021.                           (8 marks)

 

(c) COVID-19 has decimated many economies and many small and medium sized businesses have struggled to find sources of business finance during the crisis. Discuss.                                                                                      (12 marks)

Expert answer

 

There can be a conflict of interest between managers and shareholders because they may not always have the same objectives. For example, shareholders may want to maximize profits, while managers may be more concerned with maximizing their own compensation. This conflict is known as the "agency problem."

 

Agency theory is a way to analyze this conflict and understand how it can lead to suboptimal outcomes for the firm. In particular, agency theory examines the incentives that agents (i.e., managers) have to act in their own interests rather than in the best interests of their principals (i.e., shareholders).

 

There are several ways to mitigate the agency problem, such as through incentive-based compensation schemes or by increasing shareholder involvement in decision-making. However, it is important to recognize that the agency problem will never be completely eliminated; there will always be some degree of conflict between managers and shareholders.

 

ALTERNATIVE BRIEF ANSWER

 

The potential conflict that can arise from the principal-agent relationship is a key concern of agency theory. This theory posits that there is always a potential conflict of interest between managers (agents) and shareholders (principals) because they may have different objectives. For example, managers may be more concerned with their own short-term interests, such as bonuses or job security, while shareholders may be more interested in long-term profitability and growth. This conflict can lead to suboptimal decision-making and even fraud, as managers may make decisions that are not in the best interests of the company but benefit them personally.

 

Agency theory is a useful framework for understanding the potential conflicts that can arise from the principal-agent relationship. By understanding this theory, managers and shareholders can be aware of the potential for conflict and take steps to mitigate it. For example, they can put systems in place to align incentives, such as linking bonuses to long-term performance measures. With a better understanding of the potential for conflict, both managers and shareholders can work together more effectively to create value for the company.

 

There can be a potential conflict of interest between managers and shareholders due to the different objectives they may have. This is because shareholders are typically interested in maximizing their return on investment, while managers may be more concerned with advancing their own careers or agendas. Agency theory attempts to explain this conflict by positing that there is an inherent tension between the goals of the two parties. When this tension is not managed effectively, it can lead to suboptimal outcomes for the company as a whole. In some cases, this conflict of interest can even result in fraud or other illegal activities. It is therefore important for companies to put mechanisms in place to mitigate these risks, such as effective communication and oversight. There can be a potential conflict of interest between managers and shareholders due to the different objectives they may have. This is because shareholders are typically interested in maximizing their return on investment, while managers may be more concerned with advancing their own careers or agendas. Agency theory attempts to explain this conflict by positing that there is an inherent tension between the goals of the two parties. When this tension is not managed effectively, it can lead to suboptimal outcomes for the company as a whole. In some cases, this conflict of interest can even result in fraud or other illegal activities. It is therefore important for companies to put mechanisms in place to mitigate these risks, such as effective communication and oversight.

 

There can be a potential conflict of interest between managers and shareholders due to the different objectives they may have. This is because shareholders are typically interested in maximizing their return on investment, while managers may be more concerned with advancing their own careers or agendas. Agency theory attempts to explain this conflict by positing that there is an inherent tension between the goals of the two parties. When this tension is not managed effectively, it can lead to suboptimal outcomes for the company as a whole. In some cases, this conflict of interest can even result in fraud or other illegal activities. It is therefore important for companies to put mechanisms in place to mitigate these risks, such as effective communication and oversight.

There is a potential conflict of interest between managers and shareholders in a company. This is because they may have different objectives. Managers may be more interested in maximizing their own salaries and perks, rather than increasing shareholder value. Shareholders are usually more interested in seeing the value of their investment increase.

 

This potential conflict of interest is known as the agency problem. It arises from the fact that there is an unequal relationship between the people who own a company (the shareholders) and the people who run it (the managers). The shareholders are the principals and the managers are the agents.

 

The agency problem can be solved by aligning the interests of managers with those of shareholders. This can be done through things like share option schemes, where managers only make money if the share price goes up. Another way to align interests is to have shareholders vote on executive pay packages.

 

Despite these potential solutions, the agency problem remains a significant issue in many companies. It can lead to bad decisions being made by managers, which can damage shareholder value. It is therefore important for shareholders to be aware of this problem and to monitor the actions of management closely.

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