PART 1

1. Explain clearly what agency problem is. Focus your answer on why and how it
may occur. Give several examples based on your experience or knowledge of its
occurrence. Preferably, use local examples.

Agency problem is defined as conflicts of interest between corporate insiders, such as

managers and controlling shareholders and outside investors such as minority shareholders
which are central to the analysis of the modern corporation.

An agency problem occurs when the interests of shareholders and the management of the
company are not perfectly aligned and associated when these entities are at a conflict. In the
publicly held companies, there is a diversity of individuals with an interest in the
performance of the company. The managers and executives who run the company on a dayto-day basis, the shareholders who possess the companys stock and the board of directors
who administer the company's business development all may have different aims or ideas of
how the business can be run.

Furthermore, an agency problem occurs when the incentives between the agent and the
principal are not effortlessly affiliated and conflicts of interest might arise in between that
situation. As a result, the agent may be interested to act in his or her own interest rather the
principals interests. Conflicts of interest are almost unavoidable and inevitable. For example,
the agent tolerates the full cost of putting effort into the task passed on by the principal, but
usually the agent does not receive the full benefit which they supposed to receive and those
results from these efforts. This may create an incentive for the agent to put in less effort into

the task than he or she would do if acting on his or her own behalf. We will see some local
examples which agency costs occur.

The agency problem typically denotes to a conflict of interest between a company's

management and the company's stockholders. The manager who is acting as the agent for the
shareholders or namely the principals, is supposed to make decisions that will maximize the
shareholders wealth and minimize the companys risk of facing losses. Nevertheless, it will
be in the manager's own best attentiveness and interest to maximize and exploit his own
wealth.

There was a case where Chin Keem Feung, 46 years old and Shukri Abdul Tawad, 47 years
old was the ex-directors of Transmile Group Bhd were caught under Section 122B (b) (BB)
of the Securities Industry Act 1983. They had been locked up for issuing fallacious
information of the income statement to the Bursa Malaysia Securities Bhd which were
totalingRM989,191,000 in the fourth quarter and cumulative period of 2006, in a Transmiles
quarterly report which was not examined consolidated results for the financial year ending
Dec 31, 2006. The Sessions Court judge Datuk Jagjit Singh, had penalized RM300,000 for
both criminal, in absence six month lockup and they were charged on November 14, 2007.
Example of case studied by The Star (2010)

Malaysia Perwaja Steel Project face loss of RM2.56 billion, but actually losses RM10 billion.
In year 2002, Prime Minister Dato Seri Dr.Mahathir had confessed that Perwaja had losses
about RM10 billion. Stared with year 1982, Perwaja Steel as a government owned heavy
industry Company Corporation with the Japanese Company Nippon Steel Corporation and

invested a project with costs RM 1 billion in Terengganu in order to provide domestic

demand for steel products. At that time, Perwaja Steel was faced by the production and bears
a lot of debt in yen while interests of payment were more and more high. In 1987, Japanese
Company Nippon Steel Corporation moved out the project invested in Terengganu. At the
same time, Mahathir gave all the authority to Perwajas Principal Eric Chia. Eric Chia was
services in Perwaja for seven years and successful to solve a problem of production and debt
and took a leave in year 1995. after he leaved from Perwaja, all the deficit will be occurred,
he draw from Bank Bumiputra which is RM 860 million and EPF which is RM130 million
without discussions shareholder of Perwaja. Furthermore, he lead to Perwaja Steel losses
from RM 1 billion increase to RM 2.49 billion and RM 5.7 billion on the additional debt
crippled. The new principal of Perwaja had listed a report about Perwaja losses when services
of Eric Chia are unauthorized contracts, unwise investment, misappropriation of funds, and
poor management with broad of directors and manager, not accurate accounting record. When
happened this case, Perwajas broad of director were take action to absence the meeting,
bidding process, blatantly ignored, and not satisfied with the Eric Chia. This will be causes to
the agency problem happen because conflict of broad of director and shareholders of Perwaja.
In year 2004, Eric Chia was be charged with dishonestly authorization and paid of RM76
million but total loses was more than RM 10 billion.
Example of case studied by Wain B. (2009)

2. Determine several agency costs firms may incur because of agency problems.
Search for examples and explain.

Agency costs are known as intangible costs that are created from the conflict of shareholders
and managers benefits and those of shareholders and bondholders. Behavior of agent can
make the agency cost decrease in the firm value, which are difference with the owners.
Agency cost includes principal monitor expenditures, residual loss, combined with a set of
contract between the agent and conflict of interest and has been created since the separation
of ownership and management of the corporation which was started by agency theory.
Besides that, stockholders assign the administration of the corporate affairs to the
management and if the management makes a decision contrary to the main objective of the
corporation that is the maximization of shareholders wealth. This will cause the shareholders
to undergo agency costs.

There is an agency relationship between employees of a firm and its owners. Suppose that to
conduct normal business, an employee must travel necessitating the expenses associated with
a hotel stay. If the owners of the organization allow the employee to arrange his or her own
travel itinerary, an agency problem can occur if the employee spends more on the hotel than
is necessary to conduct business. For example, if the employee books a 5-star hotel in a major
city, takes advantage of expensive hotel services, and orders room service several times a day,
the equity of the companys owners is diminished because these high-cost expenses are not a
necessary expenditure.

Agency problems are possible because of asymmetric information between the principal and
agent. One of the results of the corporate structure is separation of control and ownership.

Separation is the direct cause of asymmetric information. With an inability to monitor agents,
the principle of self-interest suggests that agents will act in their own self-interest whenever
possible.

Management will frequently have a significant economic incentive to increase share value for
two reasons. First, managerial compensation, particularly at the top, is usually tied to
financial performance in general and often to share value in particular. For example,
managers are frequently given the option to buy stock at a bargain price. The more the stock
is worth the more valuable is this option. In fact, options are often used to motivate
employees of all types, not just top managers. For example, in 2001 Intel announced that it
was issuing new stock options to 80,000 employees, thereby giving its workforce a
significant stake in its stock price and better aligning employee and shareholder interests.
Many other corporations, large and small, have adopted similar policies.

The second incentive managers have relates to job prospects. Better performers within the
firm will tend to get promoted. More generally, managers who are successful in pursuing
stockholder goals will be in greater demand in the labour market and thus command higher
salaries.

In fact, managers who are successful in pursuing stockholder goals can reap enormous
rewards. For example, the best-paid executive in 2005 was Terry Semel, the CEO of Yahoo!;
according to Forbes magazine, he made about $231 million. By way of comparison, Semel
made quite a bit more than George Lucas ($180 million), but only slightly more than Oprah
Winfrey ($225 million), and way more than Judge Judy ($28 million). Over the period 2001
2005, Oracle CEO Larry Ellison was the highest-paid executive, earning about $868 million.

Information about executive compensation, along with lots of other information, can be easily
found on the Web for almost any public company. Our nearby Work the Web box shows you
how to get started.

Control of the firm ultimately rests with stockholders. They elect the board of directors, who
in turn hire and fire managers. The fact that stockholders control the corporation was made
abundantly clear by Steven Jobs's experience at Apple. Even though he was a founder of the
corporation and was largely responsible for its most successful products, there came a time
when shareholders, through their elected directors, decided that Apple would be better off
without him, so out he went. Of course, he was later rehired and helped turn Apple around
with great new products such as the iPod.

An important mechanism by which unhappy stockholders can act to replace existing

management is called a proxy fight. A proxy is the authority to vote someone else's stock. A
proxy fight develops when a group solicits proxies in order to replace the existing board and
thereby replace existing managers. For example, in early 2002, the proposed merger between
Hewlett-Packard (HP) and Compaq triggered one of the most widely followed, bitterly
contested, and expensive proxy fights in history, with an estimated price tag of well over
$100 million. One group of shareholders, which included Walter B. Hewlett (a board member
and heir to a cofounder of HP), once opposed the merger and launched a proxy fight for
control of HP. Another group, led by HP CEO Carly Fiorina, supported the merger. In a very
close vote, Ms. Fiorina prevailed, the merger went through, and Mr. Hewlett resigned from
the board.

Another way that managers can be replaced is by takeover. Firms that are poorly managed are
more attractive as acquisitions than well-managed firms because a greater profit potential
exists. Thus, avoiding a takeover by another firm gives management another incentive to act
in the stockholders' interests. For example, in April 2006, the management of Arcelor SA was
attempting to fight off a bid from rival steelmaker Mittal Steel Co. Arcelor's management
undertook several steps in an attempt to defeat the 20.4 billion ($24.8 billion) bid. First, the
company transferred its lucrative Canadian operations to a Dutch foundation. Next, the
company increased its dividend and promised a special dividend to shareholders when Mittal
dropped its bid or the takeover failed. These payments to shareholders meant that remaining
with current management or siding with Mittal would be financially equivalent.

PART 2
1. Develop a simple regression model with paint sales (Y) as the dependent variable and
selling price (P) as the independent variable.

a. Show the estimated regression equation.

Intercept
price

Coefficient

Standard Error

t Stat

s
390.376
-14.263

44.2
2.9

8.8
-4.9

Therefore, the estimated regression equation will be;

Y= 390.376 14.263X2

b. Give an economic interpretation of the estimated intercept (a) and slope (b)
coefficient.

The estimated intercept value of 390.376 indicates that sales (Y) will be equal to 390.376
(X1000) = 390,376 gallons when the selling price (X2) is equal to zero.
This value of X2 which lies far separate from the range over which the regression line was
estimated (recall that the lowest selling price in the sample was $12.00 in sales region (9) and
the sales estimate has no practical economic significance.
The estimated slope coefficient of 14.263 indicates that expected sales (Y) will decrease by
14.263 (X1000) = 14,263 gallons for each additional $1.00 increase in the selling price (X2).

c. Test the hypothesis (at the 0.05 level of significance) that there is no relationship
(i.e., = 0) between the variables.
H0: 2=0
Ha: 2 0
b2= 14.263
sb2 = 2.909
Therefore,

t = (14.263 0)/2.909
t = 4.903

Since the calculated t-value is less than the t-value from the table (t .025,8 = 2.306), one
rejects the null hypothesis at the 0.05 significance level that there is no relationship (i.e.,
2=0) between paint sales and the selling price.

d. Calculate the coefficient of determination.

The coefficient of determination is also known as the R-square, whereby the R2 = 0.75 for
this particular regression.
With the regression equation shown above, with the selling price as the independent variable,
it has explains that 75 percent of the variation in paint sales are in the sample.

e. Perform an analysis of variance on the regression, including an F-test of the

overall significance of the results (at the 0.05 level).

The regression output gives the ANOVA or analysis of variance as:

df
1
8
9

Regression
Residual
Total

SS
6489.81
2160.19
8650

MS
6489.81
270.02

F
24.03

H0: 2=0
Ha: 2 0
Therefore, F = MSR / MSE
F = 6489.812 / 270.024
F = 24.03
Since the calculated F-value is greater than the F-value from the table (F .05,1,8 = 5.32), one
rejects the null hypothesis at the 0.05 significance level that there is no relationship between
selling price and paint sales. Therefore, there is no relationship between selling price and the
sales of paint for the company.

f. Based on the regression model, determine the best estimate of paint sales in a sales
region where the selling price is RM14.50. Construct an approximate 95 percent
prediction interval.
The Excel regression gives the following information on R2 and the standard error of
estimate:
REGRESSION

10

STATISTI

Multiple R
R Square
Adjusted

Square
Standard Error
Observations

CS
0.87
0.75
0.72
16.432
10

Xp = $14.50
se = 16.432
Therefore,

Y' = 390.376 14.263 (14.50)

Y' = 183.563, which can be written as 183,563 gallons.

Y' - 2se

= 183.563 2(16.432)

Y' - 2se

= 150.699

Y' + 2se

= 183.563 + 2(16.432)

Y' + 2se

= 216.427

Therefore, the estimate of paint sales in a sales region where the selling price is RM14.50
are from 150,699 gallons to 216,427 gallons.

g. Determine the price elasticity of demand at a selling price of RM14.50.

ED = (dY / dX2) (X2 / Y)
ED = 14.263 (14.50 / 183.563)
ED = 1.13, which is elastic.

11

2. Suppose one is interested in developing a multiple regression model with paint sales (Y)
as the dependent variable and promotional expenditures (A) and selling price (P) as the
independent variables.

a. Show the estimated regression equation.

Dependent variable

: SALES

: 10

Multiple R

: 0.874

Squared multiple R

: 0.764

Adjusted squared multiple R

: 0.697

Standard error of the estimate

: 17.062

Variable

Coefficien

Standard error

Standard Coefficient

CONSTANT
PROMEXP
SELLPR

t
344.585
0.106
-12.112

84.245
0.164
4.487

0
0.177

4.09
0.648

Source
Regressio

Sum-of-squares
6612.203

DF
2

Mean-square
3306.102

n
Residual

2037.797

291.114

F-ratio
11.357

The answer is, Y = 344.585 + 0.106X1 12.112X2

b. Give an economic interpretation of the estimated slope (bs) co-efficient.

12

P
0.006

b1 = 0.106 whereby, a one-unit (if $1,000) increase in promotional expenditures, it will

increases the expected sales by 0.106 (x 1,000), which is 106 gallons of paint with all the
other things being equal.

b2 = -12.06 whereby, a one-unit (if $1,000) increase in the selling price, it will decreases the
expected sales by 12.112 (x 1,000) which is 12,112 gallons of paint with all the other things
being equal.

c. Test the hypothesis (at the 5 percent level of significance) that there is no
relationship between the dependent variable and each of the independent variables.

The computer output indicates that only selling price (X2) is statistically significant at the
0.05 level. The t-value for significance is t (0.25, 7) = 2.365.

d. Determine the coefficient of determination.

R2 = 0.764 whereby the model explains about 76.4 percent will be the variation in paint sales
for the company.

e. Perform an analysis of variance on the regression, including an F-test of the

overall significance of the results (at the 5 percent level).

13

At the 5 percent level, the F variables of variance on the regression are very useful in
explaining the sales of paint for the company.

f. Based on the regression model, determine the best estimate of paint sales in a
sales region where promotional expenditures are RM80(000) and the selling price
is RM12.50.

Y' = 344.585 + 0.106X1 - 12.112X2

Y' = 344.585 + 0.106(80) - 12.112(12.50)
Y' = 201.665
Therefore, the answer is 201,665 gallons of the estimated of paint sales.

g. Determine the point promotional and price elasticity at the values of promotional
expenditures and selling price given in part (f).

EA

= (Y / X1) (X1 / Y) at the base level in section (f).

EA

= 0.106 (80 / 201.665)

EA

= 0.0420

EL

= (Y/X2)(X2/Y)

EL

= 12.112 (12.50/201.665)

EL

= 0.751

PART 3

14

The Lumins Lamp Company, a producer of old-style oil lamps, estimated the following
demand function for its product:
Q = 120,000 10,000P
where Q is the quantity demanded per year and P is the price per lamp. The firms fixed
costs are $12,000 and variable costs are $1.50 per lamp.

a. Write an equation for the total revenue (TR) function in terms of Q.

P = (120,000 - Q) / 10,000
P = 12 Q / 10,000
Q = 120,000 10,000P

Total Revenue, TR = Price (P) x Quantity (Q)

TR = (12 Q / 10,000) x (120,000 10,000P)
TR = 12Q - Q^2 / 10,000
The answer is, The Total Revenue, TR = 12Q - Q^2/10,000.

b. Specify the marginal revenue function.

Total Revenue,

TR = 12Q - Q^2 / 10,000

Marginal Revenue,

MR = 12 (2 x Q^2-1 / 10,000)
MR = 12 Q 5,000

The answer is, the Marginal Revenue, MR = 12 5,000Q.

c. Write an equation for the total cost (TC) function in terms of Q

15

Total Cost (TC)

= Fixed Cost (FC) + [Variable Cost (VC) x Quantity (Q) ]

TC

= FC + VC (Q)

TC

= 12,000 + 1.5Q

The answer is, the Total Cost, TC = 12,000 + 1.5Q.

d. Specify the marginal cost function.

Marginal Cost Function (MC)

= TC

TC

= 12,000 + 1.5Q

MC

= 0 + (1 x 1.5Q^1-1)

MC

= 1.5

The answer is, the Marginal Cost Function, MC = 1.5.

e. Write an equation for total profits () in terms of Q. At what level of output (Q) are
total profits maximized? What price will be charged? What are total profits at this
output level?

Profits ()

= Total Revenue (TR) Total Cost (TC)

= 12Q - Q^2 / 10,000 - 12,000 - 1.5Q

= -Q^2 / 10,000 + 10.5Q - 12,000

Total profits () in terms of Q is = -Q^2 / 10,000 + 10.5Q - 12,000.

Total profits will be maximized when;

16

Marginal Revenue (MR)

Marginal Cost (MC)

MC [ 1.5 ]

1.5

Q / 5,000

10.5

10.5*5,000

52,500 units

MR [ 12 Q 5,000 ]
12 Q / 5,000

Total profits maximized at the quantity of Q at 52,000 units.

To find the Price of every unit that will be charged;

Q

= 52,000 units

= 12 Q / 10,000

P = 12 - 52,500 / 10,000
P = $6.75
The price will be charged at, $6.75 per unit.

To find the total profit at this output level;

Q = 52,000 units
Profit,

= -Q^2 / 10,000 + 10.5Q - 12,000

= -52,500^2 / 10,000 + 10.5*52,500 - 12,000
= $263,625

The total profit at this output level is $263,625.

f. Check your answers in Part (e) by equating the marginal revenue and marginal
cost functions, determined in Parts (b) and (d), and solving for Q.

17

= 52,000 units

MR

= 12 - Q/5,000

MC

= 1.5

MR

MC

12 Q / 5,000 =

1.5

12 Q / 5,000

1.5

- Q / 5,000

1.5 12

- Q / 5,000

-10.5

52,000

Therefore, the answer is, 12 Q/5,000 = 1.5

g. What model of market pricing behaviour has been assumed in this problem?

As the Price of the product is $6.25 and is higher than MR = MC = 1.5, this is a monopolistic
market or the market of monopolistic competition whereby it is hard for any other competitor
to enter the market and make them theirs. When the company is in the monopolistic market,
therefore, they can easily grab the market demand just on their own.

PART 4
a. Develop a payoff matrix for this decision-making problem.

18

The payoff matrix for Toshiba and Hitachi is:

HITACHI

Limited
Advertising
Campaign
Extensive
Advertising
Campaign

TOSHIBA
Limited
Advertising
Campaign
$7.5; $7.5
(Million Dollar)

Extensive
Advertising
Campaign
$4.0; $9.0
(Million Dollar)

$9.0; $4.0
(Million Dollar)

$5.0; $5.0
(Million Dollar)

b. In the absence of a binding and enforceable agreement, determine the dominant

advertising strategy and minimum payoff for Hitachi.
The dominant advertising strategy for Hitachi is an Extensive Advertising Campaign. It
yields a guaranteed minimum profit for example, the security level of $5.0 million, regardless
of which strategy Toshiba chooses to use in the business strategy which is the Extensive
Advertising Campaign.

c. Determine the dominant advertising strategy and minimum payoff for Toshiba.
The dominant advertising strategy for Toshiba is also the Extensive Advertising Campaign
because this strategy yields a guaranteed minimum profit of $5.0 million, regardless of which
strategy Hitachi chooses to use in the business strategy which is the Extensive Advertising
Campaign.
d. Explain why the firms may choose not to play their dominant strategies whenever
this game is repeated over multiple decision-making periods.

19

The firms may decide to engage in limited cooperation, such as a "tit-for-tat" strategy, when
the game is recurring over multiple decision-making periods.
By selecting such a strategy it may be possible for the firms to earn profits 50% above the
guaranteed minimum payoff.
If in the first period, each cooperate, both are better off. If either violates the trust by
engaging in extensive advertising in a subsequent period, the other reacts by also using
extensive advertising.
The thought that the stream of $7.5 million is cut down to $5 million if either violates the
collusive agreement helps firms in repeated games to decide to cooperate.

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