Analysis of Capital Structure

Introduction

Conflicts often arise between the shareholders and the management because both parties have different agendas and interest to pursue. Surfacing of such issues is prompted by personal needs and can result in diversion from the main objectives of the firm. In extreme cases, a non-cordial relationship inhibits chances of healthy competition with rivaling firms, thus setting the organization on a path of self destruction. However, early detection of the rising matters can allow for the organizational leadership to set up strategies to diffuse tension and to strengthen relationship between the principal and the agency.

The theory of agency is the most dominant in the business world. The relationship between agencies (shareholders and managers) refers to the contract where an individual engages with the other (agent) to execute a service or activity on their behalf. It entails delegation of authority and decision-making to an agent (Van Puyvelde et al., 2012). In this case, the stockholder is the principal while the manager is the agent. Often, the agent’s goal is divergent, implying that his/her best interest is not to act as per the directives of the shareholders. Consequently, the management redirects the shareholder’s main goal of profit maximization to fulfill personal interests and the needs of the organization. The agency issue arises when the decision makers are separated from organizational ownership. The conflict of interest surfaces as shareholders (principals) delegate duties and authority to agents because they lack the ability to conduct it themselves thus provide an opportunity for the management to divert resources for the accomplishment of individual interests (Brown et al., 2011). The agency problem not only exists between the shareholders and managers but also between the organization and stakeholders like investors and the public. In light of this, a need exists for customization of corporate governance model for sufficient protection of creditors’ investments and the shareholders.

Agency problem can be mitigated. Several mechanisms exist to minimize this issue. First, the most obvious strategy is the managerial shareholding. In the developed world such as China, corporations such as Baidu Inc. Practices this mechanism to provide incentives for reward and monitoring of the CEO effectively, hence an improvement in the organizational performance (Cuevas-Rodriguez et al., 2012). Secondly, the external labor market encourages the managers to shift their focus towards reputations with the employers, thus performance improvement in the process. Third, the downgrading threat as imposed by the corporate control market yields a controlling discipline on the organizational leaders and departmental heads that exhibit low performance to sustain corporation growth trajectory. Lastly, the board members have a role of monitoring management and offering support to strategic decisions prior to their implementation by the management.

To mitigate the agency problems for Baidu Inc., determination of suitable governance model in the context of the Chinese market is important. Baidu should consider adoption of appropriate corporate governance model to protect shareholders’ rights and to facilitate transparency. The move will facilitate investor confidence thus attracting more capital. As a result, the firm is able to reflect on the market credibility to avoid financial volatilities and crises (Fayezi et al., 2012). Employment of effective mechanism provides a system that allows managers to customize corporate practices to serve the interests of shareholders. Therefore, the agency theory should emphasize on the elimination of conflict between the top level managers and the organization’s owners.

Institutional Theory in China

            Business entities such as Baidu are guided by regulations and rules that ought to be practiced for survival and legitimacy. However, these regulations cannot guarantee an efficient continuous operation of the firm, thus conceiving the institutional pressures. As a mechanism, the institutional theory should be adopted to examine systems that include macro-global frameworks to interpersonal interactions between the shareholders and the management (Suddaby et al., 2013). In this way, corporations can organize themselves to employ similar traits with other business entities in a specified business sector, for instance, the social media or internet platform. Institutional mechanism incorporates three isomorphic processes namely normative, mimetic, and coercive. Coercive isomorphic process suits Baidu because it entails pressures that can be exerted to adopt appropriate governance model. In fact, coercion employs other mechanisms like authority, power, and legitimateness to instigate the form to improve transparency and serve the interests of investors. For mimetic isomorphism, Baidu can imitate similar contexts in online media platforms, though uncertainty plays a vital role in the selection criteria (Kostova et al., 2013). Normative isomorphism, on the other hand, branches from increased professionalization among the shareholders. Capital market members and the management.

Corporate Governance

            The Chinese economy has been booming for more than 30 years, thus increasing the liquidity levels in the Chinese market (Claessens and Yurtoglu, 2013). Likewise, China’s technology evolves at a rapid pace. The majority of the country’s citizens have adopted the use of social media as the main mode of communication, especially for the young population. Given the government shutdown of foreign social media such as Twitter and Facebook, Baidu thrives as a dominant for domestic market with due to minimal external competition. In this regard, Baidu performs excellently in the stock market.

Oversight

            Furthermore, the board of directors should oversee the implementation of the mechanism by senior management. They should ensure absolute compliance of the adopted mechanism as per the laid down rules by the state’s regulatory authorities. Financial stability can be ensured by operational objectives supervised and administered by Chinese capital market authorities and Baidu’s internal overseers. Eventually, first-time investors will be educated and notified on the developments hence bridging the existing gap between them and the management. Provision of timely information helps in the determination and correction of errors to limit or arrest negative impacts of financial or operational shortcomings. In turn, the firm will gain a reputation as market-efficient because it reveals the degree of Baidu’s compliance with regulations, market laws, and policies. In addition, the shareholder will understand the degree of corporation’s risk management, risk identification, market discipline, and internal controls (Larcker et al., 2011).

            Another mechanism should involve the timely, continuous, and rational provision of Baidu’s performance data as per the market condition. It allows for consideration of the level of incentives to be provided to the board members and the managers, especially if they are successful in the formulation of sound credit and investment decisions (Krause et al., 2014). Otherwise, the shareholders’ needs will hardly be adhered. Resultantly, the need for transparency in business transactions forces the firm to comply with the set standards of accounting to avert the risk of shareholder withdrawal or penalization in the stock market. Besides, the investor can assess the actual financial value of the form in terms of competitiveness, profitability, and efficiency.

Market-Oriented Mechanism

            The goal of embracing of appropriate mechanisms and models is to promote business governance status to reflect the market conditions and to avoid cases of conflicts between the firm’s leadership and the shareholders. In fact, the adopted mechanisms should be in accordance with the international principles and standards for positive reflection on risk management and to address the challenges of globalization (Bell et al., 2014). In China, market-oriented mechanisms rely on mandatory regulations by the central government to protect shareholder’s interests. They are dependent on both formal and informal models of hostile takeovers and incentive-based compensational structure to monitor the accountability of the directors and managers. If this is the case, it is clear that the board members and the management craft corporate laws to seamlessly fit the demands of shareholders and the market circumstances. Under this mechanism, full disclosure requirement could suffer a setback because of shielding of performance data from regulators and shareholders.

            In this mechanism, the regulatory bodies have fewer roles to play, thus rendering the unofficial models to regulate the governance process. In fact, the mechanism works best in unrestricted economies such as the United States and other Western markets whose business forces measure and determine organizational performance. Furthermore, this model requires the shareholders to be aware of the market mechanisms to speculate the decisions to be made by the management (Bubb and Warren, 2013). Market-oriented mechanism affects emerging Asian market if Baidu adopts it because of the shortage in coping with fast technological evolution on the global platform. Moreover, Baidu and other corporations headquartered in China are subject to multiple levels of overlapping rules as most of them strive to enact and implement cost effective mechanisms to mitigate agency issues.

Organizational Governance System

 The merging of requirements to a single course for the attainment of shareholders’ needs calls for a development of enterprise-wide and holistic organizational governance system that employs technological tool to improve effectiveness in compliance with the set rules. Further, the system should focus the attention of management towards transparency. If transparency lacks within the internal business environment, the chances are that the shareholders’ interests will be exploited in the hands of corporate insiders. Consequently, Baidu’s strategists should conduct extensive research and development to update the existing knowledge and to measure the impact of opaqueness in transaction on the response of shareholders to market behavior.

Business regulatory authority in China can protect shareholder’s interest by enacting mandatory policies and laws that define the rights of shareholders. The model will be enforceable rigorously by the firm’s management to enable market forces to measure performance as per financial data and reliable, accurate operations (Haque et al., 2011). Not only does this protect the shareholders from mismanagement and abuses but also, controlling shareholders are inhibited from exercising opportunism against minority stakeholders. However, it is worth noting that a large section of Baidu’s shareholders in China and abroad possess little knowledge of the capital market operations.

            Managers that own less than 100 % of common stock in the organization are more likely to experience agency-related issues with the shareholders because they can make decisions that are in sharp contrast with the best interest of stockholders (Ingley and Van Der Walt, 2015). For instance, malicious managers can exercise unethical business practices growing the firm to avoid foreseeable attempts of the takeover to keep their jobs. What they do not realize is that the planned takeover is in the shareholders’ best interest. In the modern business environment, a scenario like this is avoidable if primary mechanisms are instituted to motivate the managers. Studies indicate that genuine motivation results in the management acting in the firm owners’ best interest.

Compensation

            Compensation of Managers as per their input and efforts ought to be constructed to align shareholders needs those of the leadership besides assuring the retention of competent managers. The mechanism can be implemented by adding company shares and performance bonuses to the annual salary (Deutsch et al., 2011). The shares of the business entity are distributable to managers as executive stock options or performance shares. In the case of stock options, the managers have an opportunity to acquire shares at a future price and date. Use of stock options renders managers as shareholders, hence aligning them closer to the interests of other stockholders.

Direct Intervention

            Shareholders are empowered to intervene directly in the case of non-responsive management. Currently, large institutional investors own stocks and shares (including mutual funds and pensions) in multinationals such as Baidu. Consequently, they can exert influence on the firm’s operation and the organizational leadership should they chose to. In fact, they can threaten to fire the managerial staff especially if they are unhappy with the direction of the company. Their close relations with the board allow them to forge for reshuffle or total overhaul of the existing management. Still, the shareholders can re-elect a new BOD for their demands to be met (Dalziel et al., 2011). Deterioration of stock price due to managerial incompetence can result in the introduction of new managers by the stockholders to restore control of interest.

The organization can be motivated to achieve and facilitate undertakings by proper corporate governance to meet the goals and to assure development for shareholder’s benefit. In this way, it is possible for Baidu to attract international investors and to expand its global prospects. However, the move cannot be beneficial unless the market readies itself in terms of clear governance regulations and transparency. Such an adoption demands a legislative business environment to set a comprehensive strategy and to enforce the implementation process for attainment of accountability and responsibility. Additionally, agency problem mitigation can be an added factor because it facilitates a smooth flow of information and operations within the business environment. Investors would not wish to encounter challenges like redundancy, information breakdown or alteration in the process of doing business.

Conclusion

It is clear that numerous mechanisms exist to mitigate agency problems common in most corporations. Motivation of the workforce is fundamental towards eliminating cases of dissatisfaction that can trigger conflict with the stakeholders. In addition, the board should exercise its oversight authority over the management to restore stockholder’s confidence and to encourage investment for organizational growth. On the other hand, shareholders are empowered to re-elect new leadership or to threaten underperforming managers.

References

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