Characteristics of Agency Theory

Characteristics of Agency Theory

Characteristics of agency theory may be explained in term of separation of ownership and management, management act in best interest, management self interest, conflict between management & owners, Management create cost and balance approach.

1.    Separation of Ownership & Management

Under agency theory management & ownership are two different aspect of organization. Business is managed by manager hired by the owners. Manager acts on behalf of the owner as agent.

2.    Management act in Best interest

Under agency theory, it is believed that manager will work in the best interest of ownership. Therefore a formal hired by the owners to manage the business. It is an ideal situation or case of agency theory.

3.    Management Self Interest

Agency theory recognizes the fact, that management may have their self interest like increase in salary and bonuses. Therefore it is not practical that manager will only focuses on the interest of owners.

4.    Manager & Owner Conflict

Agency theory recognizes that Manager Interest and owner interest conflict with each other. Management may look into short term profit, while ownership is more interested in long term growth. Manager is ready to take risky decision, while owner would love to minimize the risk.

5.    Manager Create Cost

Agency theory explains that Management create number of costs for the ownership. For example an increase in salary is cost for the ownership, as it will reduce the ownership wealth. It is important to remember that any cost of expense is a hit on ownership wealth.

6.    Balance

Agency theory explains a balance between management and ownership. Management should look to ownership interest and ownership should also give due consideration to self interest of management.

Characteristics of Stakeholder Theory

Characteristics of Stakeholder Theory

Characteristics of Stakeholder theory can be explained in term of multiple objectives, director are not agent, and responsibility toward society.

1. 1.    Internal & External Stakeholder

There are number of stakeholder for any organization, which can be broadly classified into internal stakeholder i.e. Employees, supplier and external Stakeholder like Government.

1. 2.    Stakeholder are important

Stakeholder theory believes that stakeholder is important for the business, and therefore organization should adopt appropriate policies to cater their concern and safeguard their interests.

1. 3.    Multiple Objectives

      Stakeholder theory believes there are number of objectives for an organization. There are       different stakeholders and each stakeholder interest is to be safeguarded by the organization.

1. 4.    Directors are not Sole Agent

Director cannot be regarded as sole agent of the shareholder; rather they are responsible to safeguard the interests all stake holders.

1. 5.    Responsibility toward Society

Company also has responsibility toward the society. Therefore due consideration should be given to the issues which effects the society like environmental issues. The example of environmental issues is emission of carbon, noise and pollution, depletion of natural resources.

Advantages of Floating Rate of Interest

Advantages of Floating Rate of Interest

Advantages of floating rate of interest are that you may require paying lower amount, if the interest rate falls or goes down. It means that you may require to pay amount lower than your expectations.

Example

ABC Company borrowed 2 million at LIBOR + 2 %, company was expecting that labor would remain 5%, but actual labor came down to 3%.

Expected Interest (5%+2%) x 2,000,000 = 140,000

Actual Interest (3%+2%) x 2,000,000     = 100,000

Advantage= 140,000-100,000 = $ 40,000

Disadvantage of Floating Rate of Interest

Disadvantage of floating rate of interest is that you may have to pay more than you are expecting to pay, and you will face difficulty to arrange this extra amount.

Example

For example you have borrowed 1 million dollar, predicting that interest rate would remain in single digit, but if rate crosses the single digit. Your bad time starts.

Maximum Interest Cost 1,000,000 x .09 = 90,000

Actual Interest Cost 1,000,000 x 12% = 120,000

Excess cost        120,000-90,000 = $ 30,000

One have not planned for this extra $ 30,000, therefore you may face some serious difficulties to arrange this $ 30,000.

Why Present cash flow is divided by annuity factor for equivalent future cash flows

Why Present cash flow is divided by annuity factor for equivalent future cash flows?

Present cash flows are divided by annuity factor to account for the time value of money; this is very important concept in financial decision making. If we ignore the time value of money, then we can divide the present cash flow with number of years.

What is asset replacement rule for machinery

What is asset replacement rule for machinery?

Machinery which has lower annual equivalent cost should be selected. Annual equivalent cost can be calculated dividing the present cash flows with the annuity factor.

Asset Replacement Rule example

For example there are two machinery (X, Y) with cost 100 and 150 million respectively. Running cost of both machinery is 40 million per year and useful life is 2 & 3 years, then annual equivalent cost can be calculated as under;

Year	Initial	Running cost	Net Cash	Discount	PV
0	100		100	1	100
1		40	40	.909	36
2		40	40	.826	33
PV					169

Annuity Factor (2 Years) = 1.73

Equivalent machinery cost = 169/1.73

= 98 (first Machinery)

Year	Initial	Running cost	Net Cash	Discount	PV
0	100		130	1	130
1		40	40	.909	36
2		40	40	.826	33
		40	40	.751	30
PV					229

Annuity Factor= 2.48

Equivalent Machinery Cost= 229/2.48

=92 (second Machinery)

Second machinery has lower equivalent cash outflow, and therefore be selected.

Who can demand fresh election of Board of Director

Who can demand fresh election of Board of Director?

Fresh election can be demanded by a substantial shareholder. Substantial shareholder may claim his representation in board of directors. In Pakistan substantial shareholder mean a person holding more than 12.5% of shares.