Agency costs - Free Essay Example

Sample details Pages: 7 Words: 2139 Downloads: 3 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? 1.What are agency costs, and how are agency costs of financial distress different from agency benefits of leverage? Explain their impact on calculating the value of a firm with financial distress. Agency costs arise when conflicts of interest occur among stakeholders and must be paid out to an agent acting on behalf of a principal. There is an agency cost that exists in every business that has owners or shareholders and managers who are not necessarily owners. Agency cost means that shareholders and business managers may not necessarily agree on the actions that are best for the business firm and that there is an inherent cost to that disagreement. That leads to what is called the agency problem. When a firm has leverage, a conflict of interest exists if investment decisions have dissimilar consequences for the value of equity and the value of debt. These conflicts happen when there is a high concern of financial distress and can only arise when there is a chan ce that the firm will default. For example, if the firm managersà ¢Ã¢â€š ¬Ã¢â€ž ¢ actions are positive for the shareholders but negative for the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s creditors which, in turn, lowers the overall total value of the firm. Shareholders wish for management to run the company in a way that increases shareholder value. On the other hand, management may wish to grow the company in ways that capitalize on their personal power and goals that may not be in the best welfare of shareholders. Agency costs of financial distress are different from agency benefits of leverage because even though equity holders may benefit at the expense of debt holdersà ¢Ã¢â€š ¬Ã¢â€ž ¢ from these negative NPV actions taken in times of distress, debt holders recognize this move and pay less for the debt when it is first issued, reducing the amount the firm can dole out to shareholders. The net result is a reduction in the initial share price of the firm corresponding to the negative NPV of the a ctions. Ultimately, it is the shareholders of the firm who swallow these agency costs. Agency costs represent an additional cost of growing the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s leverage that will affect the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s optimal capital structure choice. The costs increase with the risk, i.e., the amount of debt held by the firm. Here are some agency costs of leverage: à ¢Ã¢â€š ¬Ã‚ ¢Excessive risk taking and asset substitution à ¢Ã¢â€š ¬Ã‚ ¢Debt overhang and under investment à ¢Ã¢â€š ¬Ã‚ ¢Cashing out Debt maturity and covenants can help to mitigate the agency costs of debt. The degree of agency costs frequently depends on the maturity of debt. Agency costs are highest for long-term debt and smallest for short-term debt. Debt Covenants are conditions of writing a loan in which creditors place limitations on actions that a firm can take. Covenants may help to reduce agency costs; nonetheless, because covenants hinder management flexibility, they have the possibility to avert investment in positive NPV opportunities and can have costs of their own. 2.When securities are fairly priced, why would the original shareholders of a firm pay the present value of bankruptcy and financial distress costs? In the realm of finance, a security refers to any proof of ownership or debt that has been assigned a value and may be sold (The Street, 2014, 1). For the holder, a security represents an investment as an owner, creditor or rights to ownership on which the person hopes to gain profit, such as stocks, bonds or financial options (The Street, 2014, 1). When a company files for bankruptcy or faces a time of financial distress, every individual with a stake in that respective company à ¢Ã¢â€š ¬Ã¢â‚¬Å" from employees to creditors to stockholders, etc. à ¢Ã¢â€š ¬Ã¢â‚¬Å" is essentially linked to the future of that company in terms of how a bankruptcy proceeding may unravel. As such, individuals who hold securities in certain companies have varying change s of getting repaid. It is in this capacity that original shareholders of a firm may pay the present value of bankruptcy and financial distress costs in order to à ¢Ã¢â€š ¬Ã…“curbà ¢Ã¢â€š ¬Ã‚  the effects that an escalating financial issue may have on individual stakeholders as well as the overarching company. Research has found that a shareholder in a company or firm à ¢Ã¢â€š ¬Ã¢â‚¬Å" especially those who have signed on and been a part of that company since the beginning à ¢Ã¢â€š ¬Ã¢â‚¬Å" hold a priority position in relation to assets of the debtor corporationà ¢Ã¢â€š ¬Ã¢â€ž ¢s estate and their ability or inability to realize on their interests and securities (Kelch, 1993, 264). Thus, when shareholders have been permitted to retain economic interests in debtor or financially unstable companies, those individuals maintain a respective say in what happens to that company, in other words, acting on good faith (Kelch, 1993, 264). 3.What are the dividend payment process an d the open-market repurchase process? In your answer, be sure to explain the effects they have in a perfect world. The dividend payment processes, or dividend payment procedures set a procedure that follows: declaration date; ex-dividend date; holder of record date; and payment date. Declaration date is the announcement that a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s overseeing board of directors has approved the payment of a dividend. The ex-dividend date is the date is the date upon which investors are à ¢Ã¢â€š ¬Ã…“cut offà ¢Ã¢â€š ¬Ã‚  from receiving a dividend. For example, if an investor purchases a stock on the ex-dividend date, that investor will not receive the dividend, as this date is two business days before the holder-of-record date (Investopedia, 2014, 1). The ex-dividend date is important as from the day it is issued and forward, new stockholders will not receive a dividend, and as a result, the stock price of a company will be reflective of this. The holder of record date is the date upon which the stockholders who are able to receive the dividend are recognized. Finally, the payment date is the date upon which an actual dividend is paid out to the stockholders on record. The open-market repurchase process, on the other hand, is the reacquisition by a company of its own stock. Open market repurchases are legal transactions to reacquire a company which are generally encouraged by regulators to avoid instances of insider trading or liability. In terms of a repurchase, the open market method is largely considered to be the most common share method in the United States. In cases where this is an option, a firm or company will announce that it will repurchase some shares in the open market from time to time as market conditions dictate. In this capacity, a company or firm holds the upper hand in terms of repurchasing, as it will decide when, where, and how much of a company to repurchase, and this tactic can take upwards of months and years to be complet ed. 4.What are the benefits and drawbacks of accumulating cash balances rather than paying dividends and what effects do dividend policy have on this type of decision? Today, many companies are accumulating cash balances rather than paying dividends in the wake of an uncertain fiscal and economic future. As dividend policy is largely concerned with financial policies regarding paying cash dividends in the present or paying an increased dividend at a later stage, many companies remain uncertain about their respective statuses at this à ¢Ã¢â€š ¬Ã…“later stageà ¢Ã¢â€š ¬Ã‚  in the game and are choosing to opt out of dividend policy all together. As dividend policy as well as the time and extent of these dividend policies must be chosen by a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s management team, various factors must be taken into account by these managerial higher-ups in order to impose dividend policy on the entirety of a company, often effecting stocks, shareholders, taxes, and the opt ion to gain or maintain securities. For many companies, the future is generally unstable and indeterminate, and as such, many companies are choosing a less-risky option, accumulating cash balances. CNBC notes that amid recent lackluster earning seasons, that featured many companies missing sales expectations, cash balances have swelled significantly, and corporations are now stowing away cash at record rates, reluctant to invest in their businesses or hire new workers as uncertainty continues to cloud the future (Cox, 2012, 1). This research, as well as an overarching uncertainty regarding the future of fiscal policy and economics in general in the United States and across much of the western world has found that many people are far less concerned about financial risks and are more concerned about the capacity for growth, both on an individual as well as a corporate level. In a post-recession environment, investors and businesses seem to be on a separate page, but both in underst anding as to why certain companies are holding onto cash. For instance, CNBC notes: à ¢Ã¢â€š ¬Ã…“Thereà ¢Ã¢â€š ¬Ã¢â€ž ¢s this free-floating waiting period . . . waiting for certaintyà ¢Ã¢â€š ¬Ã‚  (Cox, 2012, 1). 5.What impact does asymmetric information have on the optimal level of leverage? In your answer, be sure to describe the implications of adverse selection and the lemons principle for equity issuance, as well as the empirical implications. Asymmetric information is found in a situation in which one party in a transaction has more or superior information as compared to the other party in that transaction. For instance, asymmetric information can occur when a seller knows more than a buyer or vice versa, and such an instance can become harmful due to the fact that one party has the opportunity to take advantage of the other. In this case, the party with the increased level of information essentially has all the leverage in a financial deal, because he or she can ta ke the excess information into account and force the hand of the other member of the transaction, in effect. In this capacity, there comes a chance of adverse selection, in which undesirable results can occur when buyers and sellers possess the aforementioned asymmetric information, and because individuals have access to different information, undesirable products or services are more likely to be selected in the respective transaction. Also into play comes the lemons principle, which says that in the presence of people in a market who are ready to offer bad or inferior goods, these inferior goods tend to wipe a market out of existence if it isnà ¢Ã¢â€š ¬Ã¢â€ž ¢t empirically possible to distinguish the good products from the bad. As such, if a seller is in a lemons situation, that seller has to send the right signals to the prospective buyers in order to distinguish oneself from others to gain a customerà ¢Ã¢â€š ¬Ã¢â€ž ¢s confidence in the services and terms of an agreement tha t is being offered. In this manner, typically, good companies and products are able to distinguish themselves from the bad, empirically paying higher dividends, higher returns, and the like. 6.Compare and contrast mature profitable firms with stable cash flows with firms with higher risk (dependencies on economy) with unstable cash flows. What risks do they take in regards to leverage use, tax shields, and trading information between managers and investors? Mature profitable firms with stable cash flows are far more reliable in terms of fiscal and economic responsibility to shareholders than are higher risk firms with unstable cash flows. In certain situations, these high-risk firms, which are largely dependent upon the economy, have the ability to provide their shareholders with extreme levels of success and wealth, should the economy be in a state of influx and prosperity. In such cases, significant increases in cash flow allow shareholders to believe à ¢Ã¢â€š ¬Ã¢â‚¬Å" albe it irrationally à ¢Ã¢â€š ¬Ã¢â‚¬Å" that these firms are extremely successful and will reap these kinds of benefits for years to come, essentially making their shareholders rich. However, such prosperous situations are not the norm, and occur only in situations of economic prosperity, which sets shareholders up for instances of exceeding loss as well as success, which can leave these shareholders only breaking even or finding themselves at a loss. As such, the more reliable investment appears to be the more reliable and stable companies, which bring in reasonable and steady cash flows over time. Just as a shareholder takes on a risk in becoming involved with these high-velocity companies, so do managers and higher-ups within these firms. For instance, taxation, trade and everyday business may seem easy enough when a company or firm is experiencing high levels of cash flow and success, but when this success goes away; companies like this are prone to implode upon themselves. As suc h, these times of uncertainty significantly harm investors, managers, employers and all shareholders, who exist at the mercy of a volatile company. References Cox, J. (2012). à ¢Ã¢â€š ¬Ã…“Companies are sitting on more cash than ever before.à ¢Ã¢â€š ¬Ã‚  CNBC. Web. Retrieved from: https://www.cnbc.com/id/49519419 on 23 May 2014. Investopedia. (2014). à ¢Ã¢â€š ¬Ã…“Dividend payment procedures.à ¢Ã¢â€š ¬Ã‚  Investopedia. Web. Retrieved from: https://digitalcommons.law.umaryland.edu/cgi/viewcontent.cgi?article=2863context=mlr on 23 May 2014. Kelch, T. (1993). à ¢Ã¢â€š ¬Ã…“Shareholder control rights in bankruptcy.à ¢Ã¢â€š ¬Ã‚  Maryland Law Review, Web. Retrieved from: https://digitalcommons.law.umaryland.edu/cgi/viewcontent .cgi?article=2863context=mlr on 23 May 2014. The Street. (2014). à ¢Ã¢â€š ¬Ã…“Securities Definition.à ¢Ã¢â€š ¬Ã‚  The Street. Web. Retrieved from: https://www.thestreet.com/topic/47042/securities.html on 23 May 2014. Don’t waste time! Our writers will create an original "Agency costs" essay for you Create order

Higher Indirect Taxes Imposed By The Government - 1832 Words

ïÆ' ¼ Higher indirect taxes imposed by the government – for example a rise in the duty on alcohol, cigarettes and petrol/diesel or a rise in the standard rate of Value Added Tax. Depending on the price elasticity of demand and supply, suppliers may pass on the burden of the tax onto consumers. ïÆ' ¼ A fall in the exchange rate – this can cause cost push inflation because it normally leads to an increase in the prices of imported products. For example during 2007-08 the pound fell heavily against the Euro leading to a jump in the prices of imported materials from Euro Zone countries. Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply curve. The fall in SRAS causes a contraction of GDP together with a rise in†¦show more content†¦This as shown in the diagram, Demand-pull inflation happens when aggregate demand (AD) increases in an economy and intersects the short run aggregate supply curve (SRAS) to the right of where SRAS and long run aggregate supply (LRAS) cross. This causes some inflation to occur in the short run, and even more in the long run as the economy adjusts (and the labor market moves back to equilibrium). Demand-pull inflation can occur for an reason that causes AD to increase but the most common are expansionary fiscal and monetary policy, and positive expectations about the future (increased growth/income expectations). The Demand pull inflation (FIGURE 3) Again, Demand pull inflation occurs when aggregate demand and output is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap. When there is excess demand in the economy, producers are able to raise prices and achieve bigger profit margins because they know that demand is running ahead of supply. Typically, demand-pull inflation becomes a threat when an economy has experienced a strong boom with GDP rising faster than the long run trend growth of potential GDP. Some of the possible causes of demand pull inflation are; ïÆ' ¼ A depreciation of the exchange rate which makes exports more competitive in overseas markets leading to an injection of fresh demand into the circular flow and a rise in national and demand for factor resources – there may

Ignorance Is Bliss Free Essays

Ignorance is Bliss In Sophocles’ â€Å"Oedipus Rex† and Athol Fugard’s â€Å"Master Harold and the Boys† we see the protagonists evolve from ignorance to knowledge in several different ways. As we watch this evolution we see both characters start at ignorance in very similar ways and while both take very different routes they end their journeys with similar complex consequences resulted from the knowledge they gain along the way. In â€Å"Oedipus Rex† the protagonist, Oedipus, starts from his entrance in the story at a place of ignorance. We will write a custom essay sample on Ignorance Is Bliss or any similar topic only for you Order Now He is naive to the truth about his life and the direction it is heading. Oedipus is unaware that he is King Laios’ son and he will ultimately fulfill his destiny to kill his father and marry his mother, no matter what steps he or his parents take it is a fate they cannot run from. Oedipus’ knowledge comes only later when he realizes the truth, that he is in fact King Laios’ son and when he murdered the king along the road where the three highways meet he did in fact kill his father and go on to marry his mother (Anti 2. 192). The knowledge of the seer’s prophecy coming true leads to Oedipus’ ruin. In â€Å"Master Harold and the Boys† the protagonist is Hally the seventeen year old shop owners son. The reader is shown Hally’s ignorance by how he acts with Sam and Willie. Hally treats these men as friends, particularly with Sam, the two are more like companions then a white boy and black hired help. Instances of this ignorance are seen in the way they spent their time together. Hally naively believes that him and Sam can be friends despite the place and time they are in and how is father treats them. Hally believes that since progress is seen in the world that he can escape his fathers beliefs and that despite Sam’s observation that some people are bad and that’s just the way it is: â€Å"Hally: It doesn’t have to be that way. There is something called progress, you know. We don’t exactly burn people at the stake anymore† (482). Like Oedipus, Hally is trying his best to fight his fate but he is only moving himself closer to it. Hally’s knowledge really comes when he and Sam begin fighting. When Hally is upset he takes that out on Sam because he can. He talks to Sam in a way only previously done by his father. This entire scene shows the realization that Hally truly is more like his father then he wanted to admit. Both Hally and Oedipus discover truths about themselves that they did not like and tried to run from, however they were unable to escape their fate and eventually succumbed to it. Oedipus’ truths are similar to Hally’s in several ways. First Hally realizes he is more like his father then he wanted to admit and in the end he just started the cycle of his fathers negative beliefs and attitudes all over again. Oedipus like Hally is also destined to become like his father, he follows in his fathers footsteps first by running from a prophecy then eventually following him to his own ruin. While Oedipus’ knowledge is more literal then Hally’s both men commit actions that have severe consequences leading them to the truths they uncover about themselves. Hally’s actions of taking his anger and frustration out on Sam causes his true ideals to come out. When he begins to act out the audience is shown just how much he really thinks like his father. Despite his best efforts to show that he believes things can change in the dynamics between whites and blacks, it is really not a strongly held idea as the beliefs of his father, that he as a white man is superior to his black help. The words he says to Sam can never be taken back and forever shifts the relationship between him and Sam, no longer friends they are now master and servant. Oedipus also deals with a similar problem. He also commits actions that completely change the shape of his life and can never be taken back. Like Hally Oedipus wants to change is fate. Where Hally does so by trying to be friends with Sam and Willie, Oedipus does this by leaving home putting as much distance as he can between himself and the man he believed to be his father. However like Hally, Oedipus in the end realizes that consequences for his actions. Killing King Laios and then marrying his queen are actions that have dire consequences for Oedipus and like Hally’s they can never be undone. While both Hally and Oedipus try to fight their fate and both commit actions that forever alter their futures, they come about in very different ways. Oedipus deals with his fate in a more literal way. Oedipus learns the prophecy he had feared his whole life was actually true by the realization that he did murder is father and marry his mother. These physical actions lead to Oedipus’ downfall and are permanent. Hally, on the other hand, comes to learn the truth about himself, that he is like his father, by his actions toward Sam. While no less severe they are more emotionally damaging and speak to the relationship Sam and he tried to have but wound up losing because of the fight. This is damaging but not quite as physical as what Oedipus went through. Throughout each story we see the evolution of the characters from their naive beginnings to the painful realization of who they truly are. Both characters come to several truths about themselves during their respective stories, in both cases their truths have significant effects. Oedipus’ knowledge leads him to his own downfall in order to save his kingdom from certain death. Hally’s truths about himself has a more hidden effect that is very significant and the true meaning behind the play. Hally’s actions during his fight with Sam causes a divide between them that is irreparable, it is the effect of this rift that is most significant. Throughout the play we see several instances of imagery used to describe the world the characters are living in and here is no different. The argument between Hally and Sam causes the same â€Å"dance† to continue. This dance is a symbol for the beliefs held by Hally’s father and the world they live in. By acting the way he did toward Sam, Hally is causing the imperfect dance to continue on. The effect of Hally’s actions causes him to start becoming more like his father then he wanted but cannot avoid. In both â€Å"Oedipus Rex† and â€Å"Master Harold and the Boys† we see several instances of the main characters moving from ignorance to knowledge. While they gained insight into themselves it came at a price. For Harold it was the loss of his innocence and a bleak look at his future with Sam and Willie, with Oedipus it was the loss of everything he thought he had and his own painful exile. Each character tried to fight their fate, Oedipus literally by trying to flee the seer’s prophecy and Hally by doing the exact opposite of his father and befriending Sam and Willie. No matter the path they took each eventually succumb to their destiny and was forced to learn more about themselves then they wanted. Despite the painful ending it was a journey they were meant to be on. Works Cited Fugard, Athol. â€Å"’Master Harold’†¦and the Boys†. Boston: McGraw Hill, 2006. Print. Sophocles. â€Å"Oedipus Rex†. Trans. Fitts, Dudley Fitzgerald, Robert. Boston: McGraw-Hill, 2006. Print. How to cite Ignorance Is Bliss, Papers