1.

Jensen and Meckling (1976) argue that investors do not need to be

concerned by managerial consumption of perks since investors
are ‘price protected’.
Yet, corporate governance initiatives, including legislation, and
corporate collapses due to mismanagement and fraud would seem
to indicate that investors should be very concerned.
Does this mean as a theoretical proposition, Jensen and Meckling
is more or less irrelevant in the ‘real’ world?
Answer:
Jensen and Meckling (1976) theory

The Jensen and Meckling theory, foundational to understanding the modern

corporation, emphasizes the agency costs arising from the separation of
ownership and control in firms. This separation leads to conflicts of interest
between managers (agents) and shareholders (principals), resulting in agency
costs. These costs include monitoring expenses by the principal, bonding costs
by the agent, and the residual loss due to divergence in the principal's and
agent's interests.

The theory also explores the implications of these agency costs on the firm's
ownership and capital structure. It suggests that managers, when not fully
owning the firm, may not act in the best interest of the shareholders, potentially
leading to decisions that reduce the firm's value. This misalignment is due to
managers pursuing personal benefits at the cost of shareholder value, known as
"quiet life" behavior or engaging in activities that may not align with
shareholder interests.

Jensen and Meckling propose that efficient capital markets price in these agency
costs, influencing the firm's capital and ownership structure. The theory
underscores the importance of monitoring mechanisms and governance
structures to align managers' interests with those of the shareholders, thereby
minimizing agency costs and enhancing firm value.

Jensen and Meckling

Agency relationship as a contract under which one or more persons (the
principal(s)) engage another person (the agent) to perform some service on their
behalf which involves delegating some decision-making authority to the agent.
Jensen and Meckling's theory suggests that investors are protected against
managerial perk consumption through efficient market pricing. However,
instances of corporate governance failures challenge this notion, implying that
investors should indeed be wary of managerial excesses. Despite this, the theory
remains relevant for understanding the dynamics of agency costs and the role of
corporate governance.

Empirical evidence, such as the studies by Ang et al., supports the theory's
insights into the relationship between ownership structure and agency costs,
indicating its applicability in real-world scenarios. These studies show that
agency costs do impact firm value and that effective governance can mitigate
these costs.

The theory's assumption of market efficiency is critical. It posits that as long as

markets are efficient, investors will be 'price protected'. Yet, market
inefficiencies and information asymmetries can lead to situations where
investors are not fully protected, as seen in cases of IPO underpricing.

Corporate collapses due to mismanagement and fraud further question the

theory's assumptions. These events suggest that agency problems can have
severe consequences, underscoring the importance of vigilant corporate
governance and oversight.

However, it's essential to recognize that Jensen and Meckling's framework

primarily addresses the agency costs associated with the separation of
ownership and control. It does not claim to protect against all forms of corporate
failure, indicating the need for a broader approach to corporate governance.

The theory has inspired numerous governance reforms aimed at reducing

agency costs and protecting investors. These initiatives, while not foolproof,
reflect the theory's ongoing influence in shaping corporate governance practices.

In conclusion, while Jensen and Meckling's theory may not account for every
aspect of corporate behavior, it provides a foundational understanding of agency
costs and governance. Its principles continue to inform the development of
mechanisms aimed at aligning the interests of managers and shareholders.

The relevance of Jensen and Meckling's theory in the modern business

environment is nuanced. It offers valuable insights into the nature of agency
problems but must be applied in conjunction with a comprehensive
understanding of corporate governance and market dynamics.
Ultimately, the theory underscores the importance of continuous evolution in
governance practices to address the complexities of contemporary business,
highlighting the need for a balanced approach that incorporates both theoretical
insights and practical considerations.

2.
Utilising a unique dataset, Ang et al., (2000) provide some
evidence in support of Jensen and Meckling’s key proposition
that a split in ownership and control causes an increase in agency
costs. Provide a critique of the approach used, highlighting any
potential flaws in the research design and methodology.

The research paper by Ang et al. (2000) investigates the relationship between
ownership structure and agency costs in small businesses.

It supports Jensen and Meckling's theory that agency costs are higher when
there is a separation between ownership and control.
Ang et al. use a sample from the Federal Reserve Board’s National Survey of
Small Business Finances and find that agency costs are indeed higher in firms
not entirely owned by their managers, and these costs increase as the managerial
ownership share decreases.

For a critique of their methodology, one could consider the representativeness

of their sample, the accuracy of their agency cost proxies, and the applicability
of their findings to larger firms. Their approach heavily relies on data from
small businesses, which may not accurately represent larger public corporations.

Additionally, the use of operating expense ratios and sales-to-assets ratios as

proxies for agency costs could be challenged. These ratios may be influenced by
factors other than agency costs, such as industry-specific practices or economic
conditions.

When critiquing the paper, it would be important to examine the robustness of

their results across different models and the potential for omitted variable bias.
It could also be useful to discuss whether their findings can be generalized
beyond the small business context they studied. Overall, while the paper
provides valuable insights, any critique should consider the scope and
limitations of their dataset, the proxies used, and the broader implications of
their findings.
To provide a critique of Ang et al. (2000), we'd focus on their methodology and
research design in examining the agency costs in relation to ownership and
control.
The study leverages a significant sample size from the FRB/NSSBF database,
which strengthens the validity of their results.
The incorporation of a wide range of ownership structures and the consideration
of both absolute and relative agency costs are also commendable aspects that
provide a comprehensive view of the agency costs across different corporate
structures.

However, potential critiques could include the generalizability of their findings.

Since their data is drawn from small businesses, the conclusions might not be
applicable to larger public companies.
Moreover, the unique nature of small business financing and management could
introduce biases that are not present in larger firms.
The study's reliance on the Federal Reserve Board’s National Survey might also
bring about a selection bias if the surveyed firms do not represent the broader
population of small businesses accurately.

Additionally, the study assumes that firms managed by a 100% owner incur
zero agency costs, which is a strong and potentially contestable assumption as it
neglects the complexity of human behavior and the nuanced incentives that can
exist even within sole proprietorships.

In terms of measurement, while the use of operating expenses and sales-to-

assets ratios as proxies for agency costs is innovative, they may not capture all
dimensions of agency costs, such as the qualitative aspects of managerial effort
or strategic decision-making.

Lastly, while the multivariate regression models used provide valuable insights,
they might not fully capture the dynamic interplay between different factors
affecting agency costs. The econometric models could be sensitive to the
inclusion or exclusion of certain variables and might not account for unobserved
heterogeneity within the data.

In conclusion, while Ang et al. (2000) contribute valuable insights into the
relationship between ownership structure and agency costs, the study's design
and methodology have limitations that should be considered when interpreting
the results. The data source, assumptions, measurement proxies, and potential
for unobserved variables all present areas where critique and further research
could be beneficial.
The excerpt from the document discusses regression analysis results from
subsamples with high insider voting control. This analysis is segmented into
different panels each addressing a different aspect:
1. Panel A deals with the market value of cash, using annual excess stock
returns as the dependent variable. The coefficient estimate for the cash
ratio multiplied by cash is 0.999 (p-value < 0.001), indicating a highly
significant positive effect, while another coefficient is -0.063 (p-value =
0.002), showing a significant negative effect.
2. Panel B focuses on CEO compensation, with the dependent variable
being CEO total compensation. The coefficient estimate for the ratio is
0.862 (p-value < 0.001), suggesting a significant positive relationship.
3. Panel C examines acquisition decisions using the Acquirer's Cumulative
Abnormal Return (CAR) from two days before to two days after the
announcement as the dependent variable. The coefficient estimate for the
ratio is -1.005 (p-value < 0.001), which shows a significant negative
relationship.
4. Panel D analyzes the market value of large capital expenditure increases,
again using annual excess stock returns as the dependent variable. The
coefficient estimate for the CapEx ratio multiplied by CapEx is 0.960 (p-
value = 0.054), which is significant at the 10% level, and another
coefficient is -0.207 (p-value = 0.006), indicating a significant negative
effect.
Additionally, the document notes that an inverse Mills ratio (IMR) was
constructed from the first-step regression coefficients and included as an
explanatory variable in other regressions. The IMR did not have a significant
coefficient, suggesting that sample selection issues do not appear serious in the
study. Hence, the results are deemed robust against sample selection bias, as the
key explanatory variables' coefficients are similar to those reported in previous
tables
 3. Ang et al., (2000) and Masulis et al., (2011) outline two approaches to
testing the Jensen and Meckling (1976) agency theory.
Devise an alternative research design to empirically examine the Jensen
and Meckling agency proposition.

 To explore the Jensen and Meckling agency proposition, an alternative research

design could involve a comparative analysis of firms undergoing significant
ownership and management structure changes.
 This study would systematically compare pre- and post-restructuring periods
across various metrics of agency costs and firm performance.
 Utilizing panel data econometrics, this approach would allow for a dynamic
assessment of how shifts in ownership concentration and management control
influence agency costs over time.

 Further, incorporating a qualitative component, such as case studies or interviews

with key stakeholders, would enrich the quantitative findings, offering deeper
insights into the mechanisms behind observed changes.
 This mixed-methods approach would not only test the core tenets of the Jensen
and Meckling theory but also provide a comprehensive understanding of its
applicability in diverse corporate contexts.

 By examining a broad sample of firms from different industries and geographical

regions, the study would also assess the role of external factors, such as regulatory
environments and market conditions, in shaping agency costs and governance
structures.
 This global perspective would highlight the universality or limitations of the
Jensen and Meckling framework across different corporate and cultural
landscapes.

 Additionally, the research could leverage advancements in data analytics and

machine learning to identify patterns and correlations that traditional econometric
methods might overlook.
 This innovative approach would offer a novel perspective on the complex
interplay between agency costs, corporate governance, and firm performance.

 The findings from this comprehensive study would contribute to the ongoing
debate on the efficacy of various governance mechanisms in mitigating agency
costs, potentially leading to policy recommendations and best practices for
corporate governance.
 This research design, by bridging quantitative analysis with qualitative insights
and leveraging modern data analysis techniques, would provide a robust empirical
examination of the Jensen and Meckling agency proposition.