Transcript Case: XYZ company

Case: XYZ company
Actors:
• Engineer X (innovative project, $200K life
savings)
• Mrs Y (doing nothing, wealthy, has fortunate
inheritance $730K)
• Mr Z (a legal company partner, has bonus of
$250K)
Case: XYZ company
Project needs $1M for implementation.
Actors behavior:
• Engineer X does not wish to spend any penny
from his life savings
• Mrs Y is light-minded about her unexpected
inheritance
• Mr Z as a professional thinks about investment
thoroughly
Case: XYZ company
Solution:
• Engineer X: CEO, $100K investment in equity,
50% ownership
• Mrs Y: $700K investment in equity, 50%
ownership
• Mr Z: $200K investment as a credit.
Case: XYZ company
An option for opportunistic behavior:
Assume that Mr X (but not Mrs Y and Mr Z) knows that with
probability 0.5 the value of the company in year will be either
$100M (success) or $100K (failure and liquidation). This is
asymmetry of information, which is typical for agency problem.
Without opportunistic behavior of Mr X we have the following
outcomes in the case of liquidation: Mr X and Mrs Y get nothing, Mr
Z gets $100K since debt claims have higher subordination in the
case of liquidation.
Assuming opportunistic behavior Mr X sets his annual salary as an
employee at $100K. Now he gets $100K what is perfect offset of his
investment (employees salary have the highest subordination)
whereas Mr Z unexpectedly gets nothing. He had no voice to
confirm CEO’s salary. Mrs Y had her voting rights to approve or
disapprove CEO’s salary but she were too much believing in success.
The Role of Financial Assets
(1) Transfer of capital
(2) Allocation of risks
Notice that in transfer of capital Mr X was forced
to make binding investment as an attempt to
cure potential agency problem.
Notice individual risk preferences, which depend
not only on behavioral patterns but on
current circumstances as well.