Question

a) How does the separation of ownership and management in most C Corporations lead to agency conflicts?

b) Why might a hostile takeover be good for a firm and its investors?

c) Provide two historical examples of how data mining “ Big Data” has been used in finance to inform decision making.

Answer 1

(a): Separation of ownership and management in most C Corporations lead to agency conflicts because of the differences in the interests of the principal and the agents. In case of a C Corporation the principal party is the owner or the shareholders of the company and the agents are the managers of the company. The agents often have different objectives than the principal and the principal’s primary objective is value and wealth maximization for the shareholders. Often the manager’s incentives are not aligned with those of shareholders and other stakeholders and this gives rise to agency conflicts. It should be noted that managers and shareholders have different interests and asymmetric information (usually the agents have more information). This makes the principal not always capable to ensure that the agents are acting in the best interest of the principal. In many a cases the activities that are useful to the principal are costly to the agent and this gives rise to agency conflicts.

(b): A hostile takeover can prove to be good for a firm and its investors when the acquirer (i.e. the acquiring company) is willing to pay a premium for the firm over its prevailing stock price. In such a case wealth will be created for the investors and other shareholders of the firm. In such cases hostile takeovers can prove to be good for a firm and its investors as it will create value and not destroy value.

(c ): Two historical examples of how data mining “ Big Data” has been used in finance to inform decision making are:

1. In the 2010s many insurance companies like Progressive Insurance started using data mining and ‘big data’ to analyze the driving habits of its policyholders. This helped Progressive Insurance and other insurance companies to prepare an accurate risk measurement and risk assessment framework. The companies have been continuously using data mining “Big Data” since then for this purpose.
2. Mortgage lending companies like JP Morgan Chase started using data mining “Big Data” after the 2008 financial crisis to systematically find out acceptable sales price levels for homes and commercial properties that were repossessed due to mortgages that were defaulted.