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                  366                               Corporate Finance                      BRILLIANT’S


                  Mechanisms  for  Dealing  With  Share-      eo¶ahmoëS>a-‘¡ZoOa  {ddmX  na  H$m¶©  H$aZo  H$s
                  holder-Manager  Conflicts                   àUmbr
                      There are two polar positions for dealing   eo¶ahmoëS>a-‘¡ZoOa EO|gr {ddmX na H$m¶© H$aZo Ho$
                  with shareholder-manager agency conflicts.  {bE Xmo Y«wdr¶ pñW{V¶m§ h¢:
                    At one extreme, the firm's managers are     >EH$ N>moa na g§ñWm Ho$ ‘¡ZoOg© H$mo ñQ>m°H$ ‘yë¶ ‘|
                      compensated entirely on the basis of stock  n[adV©Z Ho$ AmYma na nyar j{Vny{V© Xr OmVr h¡&
                      price changes. In this case, agency costs
                                                                  Bg pñW{V ‘| EO|gr H$s bmJV H$‘ hmoJr ³¶m|{H$
                      will be low because managers have great
                      incentives  to  maximize  shareholder’s     ‘¡ZoOg© Ho$ nmg eo¶ahmoëS>a H$s g§n{Îm A{YH$V‘
                      wealth.  It would  be  extremely  difficult,  H$aZo Ho$ {bE H$B© B§g|{Q>ìg hmoVo h¢& ¶Ú{n BZ
                      however, to hire talented managers under    AZw~§Yr¶ eVm] Ho$ A§VJ©V à{V^mdmZ ‘¡ZoOg© H$mo
                      these contractual terms because the firm's
                      earnings would be affected by economic      aI nmZm ~hþV H${R>Z hmoJm ³¶m|{H$ g§ñWm H$s A{Zª½g
                      events  that  are  not  under  managerial   Am{W©H$ KQ>ZmAm| go à^m{dV hm|Jr Omo à~§YH$s¶
                      control.                                    {Z¶§ÌU Ho$ AYrZ Zht h¢&
                    At the other extreme, stockholders could    Xÿgao N>moa na ñQ>m°H$hmoëS>g© à˶oH$ ‘¡ZoOo[a¶b H$m¶©dmhr
                      monitor every managerial action, but this   H$m {ZarjU H$a gH$Vo h¢ {H$ÝVw ¶h ~hþV ‘h§Jm VWm
                      would be extremely costly and inefficient.  AHw$eb hmoJm&

                        The  optimal  solution  lies  between  the  AZwHy$b g‘mYmZ CZ {gam| Ho$ ~rM nm¶m OmVm h¡ Ohm§
                  extremes, where executive compensation is tied  E³Or³¶y{Q>d H$m H§$ånoZgoeZ àXe©Z go Ow‹S>m hmoVm h¡ {H$ÝVw
                  to performance, but some monitoring is also  Hw$N> {ZarjU ^r {H$¶m OmVm h¡& {ZarjU Ho$ A{V[aº$
                  undertaken.  In addition  to monitoring,  the
                  following mechanisms encourage managers to  {ZåZ{b{IV àUmbr ‘¡ZoOg© H$mo eo¶ahmoëS>g© Ho$ {hV ‘|
                  act in shareholder’s interests:             H$m¶© H$aZo H$m àmoËgmhZ XoVr h¡…
                      1. Performance-based incentive plans,       1. àXe©Z AmYm[aV B§g|{Q>d ¶moOZmE§
                      2. Direct intervention by shareholders,     2. eo¶ahmoëS>g© Ûmam grYm hñVjon
                      3. The threat of firing, and                3. ’$m¶[a¨J H$m g§H$Q> VWm
                      4. The threat of takeover.                  4. Q>oH$Amoda H$m g§H$Q>&          

                                        SOLVED PRACTICAL  QUESTIONS

                   Illustration 4.2.11
                      Given the financial data of two companies A Ltd. and B Ltd. Calculate the values of both
                  companies using Net Operating Income approach:
                      A {b{‘Q>oS> VWm B {b{‘Q>oS> Xmo H§$nZrO Ho$ ’$m¶Z|{e¶b S>mQ>m {X¶o J¶o h¢& ZoQ> Am°naoqQ>J B§H$‘ EàmoM H$m Cn¶moJ
                  H$aHo$ XmoZm| H§$nZrO Ho$ ‘yë¶ H$s JUZm H$s{OE&

                                         Particulars ({ddaU)              A (`)                 B (`)
                      EBIT                                              1,50,000              1,50,000
                      Debt / S>oãQ>                                     4,00,000                   __
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