Comm101 Tut 7

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Week 7 Tutorial

Lecture: Historical development of modern business enterprises

1. What is the ‘Agency Problem’?

The ‘Agency Problem’ is a conflict of interest inherent in any relationship where one party is expected to act in another’s best interest, for principle in return for incentives. In Corporate finance, the agency problem usually refers to a conflict of interest between a company’s management and the company’s stockholders. Businesses try to solve it by it by instituting measures such as tough screening processes, incentives for good behaviour and punishments for bad behaviour, watchdog bodies, and so on. Such measures may incur huge cost for the agent, thus the agent may begin to pursue its own agenda or ignore interest of principle which cause agency problem. As said by Ron Jelich “Clients became nameless cogs in a giant money-making machine….the best interests of the clients were subjugated to the best interests of Storm and the banks”.

2. Briefly explain the main series of events that led to the collapse of Storm Financial, focusing in particular on the nature of the relationship between Storm and their bankers.

Firstly, Storm Financial encouraged their investors to buy stock by borrowing against their home and using cash to raise more money to invest. However these investors don’t have sufficient income to make the repayments.

Secondly, if the stock market fell by 10%, they were told to put in more cash and more shares, because the shares were cheap. If market rose by 10%, they were told to borrow money to buy more shares to maximise their gains. By never selling however if the market dropped too far investors would lose everything, as what happened in 2008 with the financial crisis. Some of the people with little or no income were loaded to the max with debt and persuaded to put their house and super on the line.

Thirdly, some banks gave Storm customers a special treatment. Macquarie Bank agreed to charge Storm clients lower interest...