Talk:Principal–agent problem/Archives/2017

Dr. Cadsby's comment on this article

Dr. Cadsby has reviewed this Wikipedia page, and provided us with the following comments to improve its quality:

Needs more recent references, particularly to empirical papers. There could be more references to work on the possibility of crowding out. Much of this material in this article is covered in the textbook “Personnel Economics in Practice” by Edward Lazear and Michael Gibb (3rd ed.), which should be in the further reading section. At the end of the section on the linear model, it might be useful to discuss the possibility of non-linearities in the compensation scheme leading to serious forms of cheating as emphasized by Jensen, Michael C. 2001. “Corporate Budgeting is Broken – Let’s Fix It.” Harvard Business Review, 79(11): 94–101 and Jensen, Michael C. 2003. “Paying People to Lie: The Truth about the Budgeting Process.” European Financial Management, 9(3): 379–406, and examined in the laboratory by Cadsby, C.B., Song, F. and Tapon, F., “Are you Paying your Employees to Cheat?” An Experimental Investigation,” The B.E. Journal of Economic Analysis and Policy (2010) Vol. 10, No. 1.

We hope Wikipedians on this talk page can take advantage of these comments and improve the quality of the article accordingly.

Dr. Cadsby has published scholarly research which seems to be relevant to this Wikipedia article:

• Reference : C. Bram Cadsby & Jim Engle-Warnick & Tony Fang & Fei Song, 2014. "Psychological Incentives, Financial Incentives, and Risk Attitudes in Tournaments: An Artefactual Field Experiment," Working Papers 1403, University of Guelph, Department of Economics and Finance.

ExpertIdeasBot (talk) 15:29, 24 June 2016 (UTC)

AC3410/AC3409 Coursework One Max Brown

Due: Monday 24th April 2017 at 10 am Submission method: You are required to submit an electronic version of your essay, via Turnitin Word count: 1200words (excludingtables, references). No appendices to be included. Module grade contribution: This assignment counts for 50% of the module grade Other: This is an individual assignment. There are no specific formatting requirements, except that you will be graded partially based on the professional style of the report’s formatting. Please ensure that all submissions are entirely your own work.

Please write a 200-word report plan for each of the following questions: 1. Discuss how the concepts of agency theory can be used to explain the relationship that exists between the managers of a listed company and the providers of its equity finance. Your answer should include an explanation of the following terms: (a) asymmetry of information; Information asymmetry is the situation where different individuals do not have access to the same type or amount of information. The managers of a listed company and the shareholders do not have the same information about the operations or internal situation of the business. The managers are likely to be more knowledgeable about the financial situation or operational elements of the business than the shareholders. They may use the information for their benefit at the expense of the shareholders. Oversight is necessary in order to eliminate the agency challenges where the managers benefit themselves at the expense of the shareholders. (b) agency costs; Agency costs involve the strategies put in place for ensuring that the managers act as effective agents of the shareholders. The agency costs include the potential strategies that the managers may apply in enhancing their outcomes such as earnings management. The shareholders have to put measures in place for monitoring the activities of the managers. These include the costs of strategies such as internal audits and oversight committees that are necessary for mitigating the agency problem. (c) The free-rider problem; The managers may choose take activities that involve them benefitting from the activities of other individuals or organizations. The management may choose to undertake activities that involve them free riding on the activities of the shareholders without adding any value to the organization. This free rider problem should be addressed through oversight 2. Distinguish between a primary and a secondary capital market and discuss the role played by these markets in corporate finance. What are the desirable features of primary and secondary capital markets?

A primary capital market is one where a company presents its shares for the first time. The primary market is for companies offering their stock for the initial public offering. It involves the exchange of equity ownership from a company to the public through the equity shares while the company gets capital from the public through the funds offered in exchange for the shares. The secondary market, on the other hand, involves the shares that are exchanged among member of the public. The money involved in the secondary market does not go to the companies but to the investors selling the shares. The secondary market influences corporate finance because it shows the views of the market about the company and its stock. The prices of the shares of a company in the secondary market show how the investors and other stakeholders view the company. The desirable features of the secondary market that make it effective as a tool of corporate finance is the efficiency of the prices in showing the valuation of the company and it can be used in highlighting investor perceptions about the organization. The primary capital market has the desirable features of being unaffected by public perceptions since the shares are purchased at the price quoted by the organization in question. 3. A company is planning to offer a discount for payment within 10 days to its customers, who currently pay after 45 days. Only 40 per cent of credit customers would take the discount, although administrative cost savings of €4,450 per year would be gained. If credit sales, which are unaffected by the discount, are €1.6 m per year and the cost of short-term finance is 8 per cent, what is the maximum discount that could be offered?

Customers that could take the discount = 40% * 1.6 M = €0.64 m. The total amount that could be recovered within the 10 days because of the discounts is €640,000. If the credit customers choose to take advantage of the discount, they would save the company on administrative costs as well as the need for extra funding to address the short term deficit in finances brought by the long credit period. The administrative cost saving that would be gained is €4,450. While the cost savings in terms of the need for short term finance is = 8%* €640,000 = 51,200. As a result, the total saving would be = €4,450 + €51,200 = €55,650. 4. Brand plc generates profit after tax of 15 per cent on shareholders’ funds. Its current capital structure is as follows: Ordinary shares of 50c each 200,000 Reserves 400,000

Equity 	600,000

The board of Brand plc wishes to raise 160,000 from a rights issue in order to expand existing operations. Its return on shareholders’ funds will be unchanged. The current ex dividend market price of Brand plc is 1.90. Three different rights issue prices have been suggested by the finance director: 1.80, 1.60 and 1.40. Determine the number of shares to be issued, the theoretical ex-rights price, the expected earnings per share and the form of the issue for each rights issue price. Comment on your results. Profit after tax =15% on Equity hence, the ROE = 15%. If the company wishes to raise 160,000 from the rights issue, at the price of 1.80, it would have to issue = 88,889. In this case the total share capital would be = 760,000. If the ROE = 15%, the total earnings would be €114,000. The Earnings per share = € 0.23. The form of issue is 2 for every 9 shares held. At 1.60, the number of shares = 100,000. EPS for the company is € 0.23 and the rights would be issued at 4 for every share held. At 1.40, the number of issued shares would be 114,286. EPS for the company is € 0.22 and the rights would be issued at 2 for every 7 shares held. 5. Bugle plc has some surplus funds that it wishes to invest. It requires a return of 15 per cent on corporate bonds and you have been asked for advice on whether it should invest in either of the following bonds which have been offered to it. (a)Bond 1: 12 per cent bonds redeemable at nominal at the end of two more years. The current market value per £100 bond is £95. (b) Bond 2: 8 per cent bonds redeemable at £110 at the end of two more years. The current market value per £100 bond is also £95. a. Coupon rate = 12% for 2 years. Market value = £95 and par value = £100. Using the rate function in excel, the effective interest rate for the bond = 15%

b. Coupon rate for the bond = 8% for 2 years. Market value = £95 per £100 and is redeemable at £110. Using the rate function in excel, the effective interest rate for the bond = 16% The company can invest in either of the bonds because the effective interest rates are at least 15% for both.

6. LJH plc is planning to buy a machine which will cost £900,000 and which is expected to generate new cash sales of £600,000 per year. The expected useful life of the machine will be eight years, at the end of which it will have a scrap value of £100,000. Annual costs are expected to be £400,000 per year. LJH plc has a cost of capital of 11 per cent. (a) Calculate the payback period, return on capital employed, net present value and internal rate of return of the proposed investment. (b) Discuss the reasons why net present value is preferred by academics to other methods of evaluating investment projects.

Cost = £900,000 Cash flow = £600,000 per year for 8 years Scrap value = £100,000 Costs per year = £400,000 and cost of capital = 11% a. Payback period = Cash flow – cost per year = £600,000-£400,000= £200,000. The project will generate £1 million in 5 years. Hence the payback period = 5 years. ROCE: return per year = £200,000. For its lifetime= £200,000*8 = £1,600,000. ROCE = profit/ capital employed = £200,000/ £900,000 = 22.22% The net present value = -900,000 + 200,000/(1+0.11)^1 + 200,000/(1+0.11)^2 + 200,000/(1+0.11)^3+ 200,000/(1+0.11)^4+ 200,000/(1+0.11)^5+ 200,000/(1+0.11)^6+ 200,000/(1+0.11)^7+ 200,000/(1+0.11)^8 + 100,000 = £229,224.55. IRR = b. The net present value is preferred by academics to other methods because it incorporates the time value of money. It is also preferred because it considers the differences size of investment and the variations in the periods or durations for which the investment is valued. The NPV is an efficient method of investment appraisal because it considers the market conditions through the discount rate hence it provides a good way of assessing the value of an investment.

Your report should; 1. Be presented in a professional manner.(10 marks) 2. Provide some relevant explanation of the underlying theory (10 marks) 3. Report briefly on the key identified main issues (20 marks) 4. Be academically credible. (30 marks) 5. Present summarised real world examples.(30 marks) — Preceding unsigned comment added by 197.237.24.155 (talk) 10:14, 23 April 2017 (UTC)