summary chapter 2

Question 1

An agency problem arises

Answer 1

whenever one party termed the principal relies upon actions taken by another party, termed the agent, which wil affect the rpincipals welfare. The problem lies in motivating the agent to act in the principals interest rather than simly in the agents own interest.

Question 2

Three generic agency problems arise in business firms

Answer 2

conflict between the firms owners and its hired managers

Conflict between owners who possess the majority of controlling interest in the firm and the minority or noncontrolling owners (principal)

Conflict between the firm itself and the other parties with whom the firm contracts

Question 3

Legal strategy to mean a generic method of deploying law instrumentally in a functional way - the function in this context being to mitigate the vulnerability of principals to the opportunism of their agents and can be loosely categorized into two subsets

Answer 3

regulatory strategies: are prescriptive: they dictate substantive terms that govern the content of the principal agent relationship, tending to constrain the agents behavior directly

Governance strategies: seek to facilitate the principals control over their agents behavior

Question 4

Ex ante

Answer 4

refers to the fat that the strategy takes full effect before an agent acts, while ex post strategies respond to the quality of the agents actions

Question 5

The law can dictate (principal and agents)

Answer 5

entry (for agents) and it can prescibe exit opportunities (for principals)

Question 6

There are two kinds of exit rights

Answer 6

right to withdraw the value of ones investment

Right to transfer - the right to sell shares which is obvious importance to public shareholders

Question 7

Trusteeship strategy

Answer 7

seeks to remove conflicts of interest ex anto to ensure that an agent will not obtain personal gain from disserving her principal. This strategy assumes that, in the absence of strongly focused monetary incentives to behave opportunistically, agents will respond to the low powered incentives of conscience, price and reputation and are thus more likely to manage in the interests of their principals

Question 8

reard strategy

Answer 8

rewards agents for successfully advancing the interests of their principals

There are two reward mechanisms

sharing rule: motivates loyalty by tying the agents monetary returns directly to those of the principle

Pay-for-performance regime: in which an agent, although not sharing in his principals returns, is nonetheless paid for successfully advancing her interests

Question 9

Disclosure

Answer 9

plays a fundamental role in controlling corporate agency costs. Prospectus disclsure forces agents to provide prospective principals with information that helps them to decide upon which terms they wissh to enter the firm as owners. periodic financial disclosure and ad hoc disclosure also permits principals to determine the extent to which they wish to remain owners, or rather exit the firm

Question 10

In relation to regulatory strategies that require enforcement, disclosure of related party transactions helps to reveal the existence of transactions that may be subject to challenge, and provides potential litigants with information to bring before a court. in relation to governance strategies, disclosure can be used in sevaral different ways:

Answer 10

mandating disclosure of the terms of the governance arrangements that are in place allows principals to assess appropriate internvention tactics

mandatory disclosure of the details of a proposed transaction of which the principals approval is sought can improve the princiapls decision

Disclosure of those serving in trustee roles serves to bond their reputations publicly to the effective monitoring of agents

Question 11

Enforcement

Answer 11

is most directly relevant as regards regulatory strategies. These operate to constrain the agents behavior. in contrast, governance strategies rely largely upon intervention by principals to generate agent complicance. Therefore, enforcement institutions are of first order imporatnce for regulatory strategies, but only of second order importance for governance strategies

Question 12

Public enforcement

Answer 12

all legal and regulatory actions brought by organs of the state

Question 13

Private enforcement

Answer 13

Private enforcement embraces a wide range of institutions. These include class actions and derivative suits, which require considerable legal and institutional infrastructure int he form of a plaintiffs bar, cooperative judges and favorable procedural law that facilitates actions through matters as diverse as discovery rights, class actions and legal fees.

Question 14

Gatekeeper contrl

Answer 14

strategicall placed private parties conscripted to act in the public interest: incolves the conscription of noncorporate actors in policing the conduct of corporate actors. This conscription generally involves exposing the gatekeepers to the threat of saction for participating in corporate misbehavior, or for failure to prevent or disclose misbehavior

Question 15

Penalties

Answer 15

encompass al consequences of enforcement that are likely to be costly for the defendant and thereby serve to deter misconduct. a preliminary issue concerns who should bear the liability. For legal strategies seeking to control manager shareholder and shareholder shareholder agency problems, the most obvious defendant is the agent in question. Whereas for the control of externalities, making the corporation pay the penalty encourages managers to take the expected costs of penalties into account

Question 16

The law does not apply legal strategies in the abstract but only in specific regulatory contexts. Those contexts hae been grouped into six basic categories of corporate decisions and transactions

Answer 16

regulation of ordinary business transactions and decisions

Corporate debt relationships and the problem of creditor protections

Legal regulation of related party (or self dealing) transactions

Corporate law treatment of “significant” transactions

Legal treatment of control trnasactions

Regulation of issuers on the public market

Question 17

Systematic differences: we might expect the use of various legal strategies for controlling agency costs, and of these associated modes of enforcement, to differ systematically across jurisdictions. some of these differences are

Answer 17

the efficacy of governance mechanisms is closely linked to the extent to which principals are able to coordinate; therefore the structure of share ownership affects the extent to which these strategies are employed to control managers

In systems relying heavily on regulatory strategies enforcement institutions will likely have a greater role to play in securing compliance by agents, as opposed to intervention by principals themselves

The appropriate scope of continuing disclosure obligations may vary depending ont he extent to which particular legal strategies are employed

The necessary extent of disclosure will also vary depending on the ownership structure. where owners are highly coordinated, frequent disclosure may be less important as a response to managerial agency costs