A small company, Stevens Textile Co. is expanding its operations and needs additional financing to support its expansion projects. The company is planning to change its business registration from a limited liability company to a corporation. As a corporation it will be listed on the stock exchange market and sell shares to the public to raise capital from investors. The business will be managed by professional executives who are not owners of the corporation. The company will appoint CEO and agrees to pay him $1.2 million in cash and over $25 million in stocks and options. Potential shareholders have reacted angrily to these proposals and are very likely to vote against the proposed compensation plans. The shareholders believe that the company has experienced losses over the years and agreeing to such a compensation plan will not be in the best interests of shareholders.
1. Explain agency relationship and agency costs to the owners of Stevens Textile Co.
2. Suppose Stevens Textile company is very successful and the founders’ cash out most of their stock and turn the company over to an elected board of directors. Neither the founders nor any other stockholders own a controlling interest (this is the situation in most public companies). List six potential managerial behaviors that can harm a firm’s value.
3. What is corporate governance? List five corporate governance provisions that are internal to a firm and under its control.
4. Identify three external factors outside the firm’s control that can be used to improve corporate governance and the firm value.
5. Identify five characteristics of the board of directors that usually lead to effective corporate governance.
6. Explain the following terms:
i. Greenmail
ii. poison pills
iii. restricted voting rights
7. Briefly describe the use of stock options in the proposed compensation plan.
8. What are some potential problems with stock options as a form of compensation.
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