FACULTY OF BUSINESS

BBPW3103

FINANCIAL MANAGEMENT I

MAY 2019

MATRICULATION NO : 820406075613001

IDENTITY CARD NO. : 820406-07-5613

TELEPHONE NO. : 0127616474

E-MAIL : [email protected]

LEARNING CENTRE : OUM Seremban

 Table of Contents
Description Page

1. Agency Problem 1 -2

2. Common Cause of Workplace Accident 3 -4

3. Evaluation on the health and safety practices 5 -6

4.To reduce the effects of the occupational accident 7-8

5.Summary 9

6. References 10
Agency Problem
What is agency problem ? What will be the best way to describe it in details ? As far as
my knowledge goes, agency problem is a conflict that exists in an organization between
those who are in positions of control or trust (agents) and those whose interests are to be
served (principals or stakeholders) in which actions taken by the agents instead serve
their own interests. It is a pervasive problem and exists in practically every organization
whether a business, church, club, or government.

Organizations try to solve it by instituting measures such as tough screening processes,

incentives for good behavior and punishments for bad behavior, watchdog bodies, and so
on but no organization can remedy it completely because the costs of doing so sooner or
later outweigh the worth of the results. When a principal hires an agent to carry out
specific tasks, the hiring is termed a "principal-agent relationship," or simply an "agency
relationship." In financial markets, agency problems can occur between the stockholders
(principal) and corporate managers (agents). While the stockholders call on the managers
to take care of the company, the managers may look to their own needs first. It tend to
arise more frequently in organizations that lack sufficient or effective material, moral and
coercive incentives for agents to act otherwise.

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Agency costs can really take their toll on a company's share price when there is
substantial debt involved. Shareholders and bondholders have severe conflicts of interest,
but shareholders have administrative power. They will pursue selfish strategies which
will impose agency costs and lower the market value of the whole firm.Though they are
difficult for an accountant to track, agency costs are difficult to avoid as principals and
agents can have separate motivations. Some of the famous examples of agency power can
see as below :

 Enron Fall - This is how it all begin when the energy giant in 2001 showed the
world how an agency problem arises. Enron's board of directors had failed to carry
out its regulatory role in the company and rejected its oversight responsibilities,
causing the company to venture into illegal activity. Enron were selling shares based
on false accounting reports which made it seem as though the stock was more
valuable. Many stockholders lost millions as the value of Enron shares plummeted.

 Real Estate Bubble and Goldman Sachs - When financial analysts invest against the
interests of their clients, it's another agency problem. Goldman Sachs and other
agencies created debt obligations and sold them short, with the thought that the
mortgages would be foreclosed. In 2008, when the housing bubble occurred the short
sellers made millions and many people including homeowners lost money.

 Lehman Brothers -Lehman Brothers is often cited as an example of corporate

governance failure largely due to poor oversight by the board.Lehman Brothers had a
high-leverage, high-risk-taking business strategy supported by limited equity.And
failed to carry out de-leveraging strategy in 2007 when the commercial real estate
market slowed down, which had led to the downfall of one of the oldest financial
institution.

I personally can relate to this agency problem scenario as my relatives had invested in
Maika Holdings because they were told the company would give them returns that were
10 to 20 times their initial investment.Telekom was only the first privatised government
department and shares were offered to Maika Holdings, but the offers were hijacked over
and over again by Samy Vellu and his gang.

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Agency problems and its consequences.
Shareholders therefore employ managers who will act on their behalf. The managers are
therefore agents while shareholders are principal.Shareholders contribute capital which is
given to the directors which they utilize and at the end of each accounting year render an
explanation at the annual general meeting of how the financial resources were utilized.
We are about to see in details on the failing corporate governance system, excessive risk-
taking and the greedy manager that been cited as reasons for the recent financial crisis.

How do the owners of a large business know that managers work to build shareholder
value? This lack of information is known as the principal-agent problem or the “agency
problem", which is the primarily the root cause for this entire issue. Some clear examples
that these managers are able to manipulate the accounting policies in order to report high
profits e.g. by changing stock valuation and depreciation methods, due to lack of
governance by senior management. If you remember Nick Leeson a.k.a Rogue Trader
who brought down the legendary Baring Banks as he was pursuing power and self esteem
goals.He wanted to build a new as by investing in high risk investment that looked
beneficial to managers at the expense of shareholders. In a different scenario,
shareholders might prefer high risk high return investments since they may have
diversified investment portfolios, but the managers prefer low risk investments which
have low returns.Hence, the profit generated by the company reflects the managers
performance which might put his job at stake, that might time lead to conflict of interest.

The second agency problem involves the conflict between, on one hand, owners who
possess the majority or controlling interest in the firm and, on the other hand, the
minority or non-controlling owners. Here the non-controlling owners can be thought of as
the principals and the controlling owners as the agents, and the difficulty lies in assuring
that the former are not expropriated by the latter. While this problem is most conspicuous
in tensions between majority and minority shareholders, it appears whenever some subset
of a firm’s owners can control decisions affecting the class of owners as a whole. Thus if
minority shareholders enjoy veto rights in relation to particular decisions, it can give rise
to a species of this second agency problem. Similar problems can arise between ordinary
and preference shareholders, and between senior and junior creditors in bankruptcy

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(when creditors are the effective owners of the firm).Increases in debt are directly related
to increases in risk, especially bankruptcy risk. Debt not only reduces free cash flow, but
also increases the probability of bankruptcy. It should be noted that, from a legal point of
view, bankruptcy is the process of scheduling the debt payments due to creditors when a
company is in distress.

Securitization of debt is one means of protecting bondholders’ interests that may be

incorporated in loan agreements. It is achieved by granting creditors property rights to
certain part of a firm’s assets till the loan is repayed. The collateral on fixed assets may
significantly reduce agency costs. Leasing contracts are one way of achieving this
outcome. They increase the probability that investments with positive net present value
will be undertaken, because managers will have to increase shareholders’ returns by
undertaking new investments, not by exploiting creditors (Emery – Finnerty, 1991, p.
439). Debt increases helps to make managers’ actions more rational and to make value-
maximising decisions (Green, 1993).

Another source of conflict between shareholders and managers are decisions concerning
dividend payouts and share repurchases. Such actions negatively affect the market value
of bonds, but have a positive impact on a company’s shares. A firm that has financial
strength should use them in accordance with creditors’ preferences for the repayment of
debt, in this way reducing financial risk and the costs of bankruptcy, but not shifting them
to shareholders.

Managers may reduce the value of current bonds by issuing new debt, which increases
the riskiness of the firm. The increase in risk shifts the benefits from bondholders to
shareholders. It compensates shareholders for the decrease in the market value of the
firm. There are three kinds of “selfish” strategies that shareholders use to “hurt”
bondholders and help themselves when there is a probability of bankruptcy or financial
distress. They are costly because they lower the market value of the whole firm. The 3
strategies are incentive to take large risks, incentive towards under investment and
milking the property.

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 Shareholders (principals) and auditors (agents): the auditors who are appointed by the
owners of the company to satisfy that the financial position of the company reflect the
true and fair view of the company state of affairs at a particular date in time. The auditors
may affect the interest of the shareholders causing agency problems in the following
ways:

 Colluding with management where independence is compromised

 Demanding outrageously high audit fees thus reducing company profits

 Failure to apply professional care and due diligence in the performance of their work

Numerous researches have been made about this problem as well as to the mechanisms
used to solve or act to prevent it.It is very important for shareholders to control the
agency problem because this problem leads to waste of scarce resources, hamper capital
market function and decline the economy growth.

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Reducing the agency problems in a company.
One of the solution that I can think of, would be in the use of managerial incentives and
the effectiveness of managerial monitoring. The incentive solution is to tie the wealth of
the executives to the wealth of shareholders. In this way the interests of these two groups
are aligned. Executives may be given stock or stock options, or both, as a significant
component of their compensation. The second solution is to set up mechanisms for
monitoring the behaviour of managers, with the governance from senior management.

And we also can look at ways of giving the managers to have an option of acquiring
part of the company at specified stock prices and also performance based remuneration,
where the bonuses are being paid on the performance of the company. Creating
incentives that encourage hard work on projects benefiting the company generally
encourages more employees to act in the business's best interest. The objectives are to
attract and retain able managers and to harmonize managerial actions with the interest of
shareholders. Several measures are used to evaluate managers' performance. Some of the
most common are sales, profit, current value of expected cash flows and value added.By
aligning agent and principal goals, agency theory attempts to bridge the divide between
employees and employers created by the principal-agent problem.

But there should be always a threat involved , and I meant the threat of firing. If
managers are not performing, they can be threatened with firing during the annual general
meeting or even appointing other managers. In the past it seldom happened that a senior
manager or chief executive officer was dismissed by shareholders. The reason for this
was possibly that the ownership of a great number of companies was dispersed, as well as
the fact that the agency problem was only brought to the attention of shareholders (and
management) over the past two decades.Not forgetting the threat of hostile takeovers,
where the shareholders can threaten to sell the company to another company. In some
instances, the company can become a take-over target. If the management of such a
company is replaced, the move can benefit the shareholders. The threat of take-overs can
thus serves as an external control mechanism which ensures that the decisions and actions
of management maximize shareholders' wealth.

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 Shareholders can influence the company's management in two ways. Firstly, they can
influence management directly as to how the company should be managed. Secondly, any
shareholder can make a proposal which is voted on at the annual general meeting
(AGM).Apart from that, another way to prevent the agency problem by placing effective
external control of the work of the managers. The most effective way in this situation is
to engage external audits who would periodically value the reality and objectivity of the
company’s financial reports. Precise financial reporting is critical to ascertaining that the
results are stated fairly and the management has not manipulated results for personal gain
The audit reports are delivered to the shareholders, the managers, the employees, and to
the ones who are involved at the market in order to use them as a part of the valuation of
the company.

This is quite new approach in the industry, by introducing block chain. Blockchain
technology allows for decentralized networked governance that enables the removal of
internal and external monitoring mechanisms previously necessitated by agency problems
in corporate governance. Blockchain technology creates formal immutable guarantees in
agency relationships that build the trust needed to overcome the agency problems in
corporate governance. It facilitates a substantial increase in efficiency in the agency
relationship and lowers agency costs in orders of magnitude.Supervisory tasks that were
traditionally performed by principals to control their agents can now be delegated to
decentralized computer networks that are highly reliable, secure, immutable, and
independent of fallible human input and discretionary human goodwill.

Blockchain technology provides an alternative governance mechanism that eliminates

agency costs , by creating trust in the contractual relationship between the principal and
the agent.Blockchain technology secures the integrity of principal agent relationships by
removing fraudulent transactions. Compared with existing methods of verifying and
validating transactions by third party intermediaries (banking, lending, clearing etc.),
blockchain’s security measures make blockchain validation technologies more
transparent, faster, and less prone to error and corruption. While blockchain’s use of
digital signatures helps establish the identity and authenticity of the parties involved in
the transaction, it is the completely decentralized network connectivity via the Internet

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that allows the most protection against fraud. Network connectivity allows multiple
copies of the blockchain to be available to all participants across the distributed network.
The decentralized fully distributed nature of the blockchain makes it practically near
impossible to reverse, alter, or erase information in the blockchain.

There always room for improvement, therefore, in order to overcome or even prevent
this problem, it is necessary to control the work of the managers constantly and to make
sure that the company works in accordance with the laws and the international rules in
financing. A good system of corporate governance is of great importance for an efficient
control of the companies, for the enhancement of their performances, as well as for a
better approach and availability of the external financing. Corporate governance is a term
that regards to the relations and roles of each and every party involved as interested in the
company. Corporate governance means standardization of the processes, the procedures
and the behavior of the companies. The principles of the corporate governance are as
follows: responsibility, transparency and control within the decision making process, as
well as reporting about the daily work of the company

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Conclusion
The agency problem arises when there is discrepancy between the management and
shareholders rest rather in the shareholders’ interest. Because it is difficult for a principal
to monitor the agent completely, information asymmetry might arise. This could lead to a
rise of worries the hand of the principal that the agent is acting in its own benefit instead
of in the principal’s benefit. But whenever there is a problem there is a solution for it.
And agency problem helps management to evaluate the company's strengths and
weaknesses, and it uses case study evidence to demonstrate how the theory has been
applied in different industries and contexts.

The board has the fiduciary duty to protect the interest of the shareholders, mitigating in
the agency problem is included. The composition of the board plays an important role in
this because it influences their decision making. A good control system and monitoring
in a well designed governance system is always necessary for effective control of agency
problems. We also can link the compensation to performance, also the probability of
redundancy can be used as a reduction of the agency problem. By issuing shares to the
managers they become part owner of the firm and have therefore more interest to act in
the interest of the firm. This approach also mediates the managerial risk aversion problem
because managers are triggered to maximize the firm value.

The threat of firing during periods of poor firm performance and retention during
periods of good performance encourages managers to act in the interest of the
shareholders. Let’s not forget the future remediation of agency problem by implementing
blockchain solution. Blockchain technology creates the infrastructure for decentralized
networked governance that, over time, creates the environment that enables the removal
of internal and external monitoring mechanisms previously necessitated by agency
problems in corporate governance. Blockchain technology facilitates a substantial
increase in efficiency in the agency relationship and lowers agency costs in orders of
magnitude.

In short, agency theory says that to resolve conflicts of interest between principals and
agents, give the agents some kind of stake in the venture, company, start-up, or other
business endeavor, even as you hold the agents strictly accountable. It's only common
sense, after all, that if both agents and principals have an investment that's dependent
upon a successful outcome, their interests will align, and they will work toward the same
goal: the greatest common good for the enterprise or company.

(2827 words)

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