| Course | BUS 551 Corporate Financial Management |
|---|---|
| Module | Module 1 |
| Paper type | Agency theory paper |
| Length | About 1,120 words, 7 pages |
| Format | APA 7 student paper |
| School | Aspen University |
| Program | MBA |
| Updated | October 2026 |
Free sample paper for BUS 551 Module 1
Hiring a Stranger to Run the Family Firm: Agency Costs and a Pay Package That Ties the New CEO to Long-Term Value
Student Name
MBA Program, Aspen University
BUS 551: Corporate Financial Management
Instructor Name
Month Day, Year
Hiring a Stranger to Run the Family Firm: Agency Costs and a Pay Package That Ties the New CEO to Long-Term Value
Keystone Flow Controls, a composite manufacturer of industrial valves in Allentown, Pennsylvania, has been run by members of the founding family for three generations. Its 640 employees make valves for water utilities, chemical plants and power stations, and its annual sales are about $210 million. The current chief executive, a grandson of the founder, is retiring, and no family member wants to succeed him. The family will keep all the shares and hire an experienced executive from outside. For the first time, the people who own Keystone will not be the people who run it. This paper uses agency theory to design how the family should align the new chief executive's interests with its own.
The Goal of the Firm
Before designing incentives, the owners must agree on what they want management to achieve. Brigham and Ehrhardt (2020) argue that the primary financial goal of a corporation should be to maximize the long-run value of its shares, which reflects the size, timing and risk of the cash flows the firm will generate. This goal differs from maximizing this year's profit, which can be raised by cutting research or maintenance at the expense of future cash flow. For Keystone's family, long-run value also fits their intention to hold the shares for another generation. The goal does not exclude obligations to employees, customers and the community; it treats long-run value as the financial measure within which those obligations are met.
The Agency Problem
Jensen and Meckling (1976) described the relationship between owners and managers as an agency relationship, in which one party, the principal, engages another, the agent, to act on its behalf. Because the agent's interests are not identical to the principal's, the agent will not always act as the principal would. Jensen and Meckling defined agency costs as the sum of three parts: the principal's costs of monitoring the agent, the agent's costs of bonding, or committing to act in the principal's interest, and the residual loss that remains when the agent's decisions still differ from what the principal would have chosen. Their key insight was that these costs arise even when everyone behaves honestly; they are a structural consequence of separating ownership from control.
Four Conflicts the Family Expects
Four specific conflicts are likely at Keystone. First, an outside chief executive may prefer growth for its own sake, such as acquiring a competitor, because a larger company brings higher pay and status, even if the acquisition earns less than its cost of capital. Second, if pay depends heavily on annual earnings, the executive may favor projects that raise near-term earnings while deferring investments, such as a new testing laboratory, that pay off later. Third, an executive whose wealth is concentrated in one job may avoid risky but valuable projects that a diversified owner would accept. Fourth, the executive may spend company money on perquisites, from aircraft travel to office renovations, that provide personal benefit with little value to the firm.
When Pay Itself Becomes the Problem
A natural response is to tie pay to performance. Bebchuk and Fried (2003), however, argued that executive compensation is not only a remedy for agency problems but also a product of them. Where boards are not fully independent, executives can influence their own pay, and compensation often contains features that weaken the link between pay and performance, such as bonuses based on targets that are easy to meet, options that reward general market movements, and benefits that are hard for owners to see. They called this camouflage. For Keystone, the lesson is that the family, not the new executive, must design the package, and that each element should be simple and visible.
The Compensation Design
The bonus uses return on invested capital rather than earnings or sales, because it rewards profitable use of capital rather than growth alone. The long vesting and holding periods discourage actions that lift results briefly at the expense of later years.
| Element | Amount or design | Conflict addressed |
|---|---|---|
| Base salary | $420,000 | Attracts a qualified executive; provides security that reduces excessive caution |
| Annual bonus | Up to 60% of salary, paid only when return on invested capital exceeds the 9% cost of capital | Discourages growth that earns less than its cost |
| Restricted shares | Shares worth $600,000 a year, vesting over five years and held for two years after vesting | Ties wealth to long-run value; discourages short-term earnings management |
| Expense policy | Board approval for travel and spending above set limits | Limits perquisites |
Choosing the Performance Measure
Choosing what the bonus measures is as important as its size. Earnings per share can rise through acquisitions financed with debt even when the acquisitions destroy value. Revenue growth rewards size. Stock price is unavailable for a private company and, even for public ones, moves with markets the executive does not control. Return on invested capital compared with the cost of capital rewards what owners care about: earning more on the money in the business than that money costs. It also penalizes empire building directly, since an acquisition that earns less than its cost lowers the measure.
Monitoring Through the Board
Incentives alone are not enough. Keystone's board, until now composed entirely of family members, will add two independent directors with industry and financial experience, one of whom will chair a compensation committee. The company will move from reviewed to audited financial statements and adopt a capital approval policy requiring board approval for acquisitions and for projects above $5 million.
What the Controls Cost
These safeguards have costs, consistent with Jensen and Meckling's framework. Independent directors will cost about $160,000 a year in fees and expenses. The audit will add about $90,000. Restricted shares dilute the family's ownership slightly, by about one quarter of a percent a year. There will still be residual loss, decisions the executive makes that the family would not have. The goal is not to eliminate agency costs, which is impossible, but to choose controls whose cost is less than the losses they prevent.
Recommendations
The family should adopt the compensation design above, add two independent directors before the new executive starts, form a compensation committee chaired by an independent director, move to audited statements and adopt a capital approval policy. It should review the package after three years.
Conclusion
Hiring an outside chief executive separates ownership from control at Keystone for the first time, and agency theory predicts the conflicts that follow. A package that rewards returns above the cost of capital and long-run share value, designed by the owners rather than the executive and backed by independent monitoring, can align interests at a cost the family can accept.
References
Bebchuk, L. A., & Fried, J. M. (2003). Executive compensation as an agency problem. Journal of Economic Perspectives, 17(3), 71-92. https://doi.org/10.1257/089533003769204362
Brigham, E. F., & Ehrhardt, M. C. (2020). Financial management: Theory and practice (16th ed.). Cengage.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360. https://doi.org/10.1016/0304-405X(76)90026-X
BUS 551 Module 1 instructions, in plain terms
Aspen's catalog for BUS 551 lists agency theory and corporate governance among the course's central topics, so the course opens by asking what a firm should pursue and where owners and hired managers part ways. Check your classroom for the Module 1 directions; this example applies the theory to one hiring decision. State what the firm should maximize and defend that choice. Explain how separating ownership from management creates agency problems and costs. Identify specific conflicts likely in the case rather than listing them abstractly. Propose incentives and monitoring that address each conflict, and explain their costs, since agency costs never fall to zero. Use research on executive pay and governance to test your proposals. Finish with recommendations the owners could adopt.
How this BUS 551 Module 1 example is built
The paper opens with Keystone Flow Controls, whose third-generation owners are retiring from management but keeping their shares. A section defends long-run shareholder value as the financial goal, distinguishing it from short-term earnings. Jensen and Meckling's Journal of Financial Economics article defines agency costs as monitoring, bonding and residual losses. Four conflicts are identified: empire building, short-term earnings management, excessive caution and perquisites. Bebchuk and Fried's Journal of Economic Perspectives article explains how managers can influence their own pay and how pay can be camouflaged. A compensation table assigns each element a purpose: salary of $420,000, a bonus tied to return on invested capital above the cost of capital and restricted shares vesting over five years. Monitoring through two independent directors and audited reporting completes the design, with its costs estimated.
Where the marks sit in the BUS 551 Module 1 rubric
Agency papers in an MBA finance course are graded on accurate use of theory, specific application to the case, and incentive designs that address identified conflicts at a reasonable cost. This example states and defends the firm's goal before discussing conflicts, which gives the analysis a standard to measure against. Jensen and Meckling's Journal of Financial Economics article supplies the definition of agency costs, used to categorize every safeguard proposed. Bebchuk and Fried's Journal of Economic Perspectives article prevents the naive assumption that more stock-based pay always solves the problem. Brigham and Ehrhardt's text supports the link between shareholder value and cash flow. The compensation table ties each element to a conflict, and the paper estimates what the controls cost, showing the student understands that the goal is to minimize total agency costs, not to eliminate them.
Common BUS 551 Module 1 mistakes, and how to avoid them
Students often describe agency theory in general terms without identifying the specific ways a manager's interests could diverge in their case. Name the conflicts and the behavior each would produce. Another weakness is proposing stock options or bonuses as if incentives were free and foolproof; they can encourage short-term thinking or risk taking and can be manipulated. Tie each incentive to a measure that reflects long-term value. Include monitoring, not only incentives. Estimate costs where you can. Be careful with the goal of the firm: shareholder value is not the same as this year's earnings or share price, and the distinction matters for incentive design. Finally, keep the tone balanced; agency theory describes predictable tendencies, not assumptions that managers are dishonest.
Write yours, or have the desk draft it
This paper is an original model document written by our desk, not a submitted student paper and not an official Aspen University document. Read it for the moves, then write your own to the instructions in your classroom. If you want one built to your exact prompt and rubric, the first custom sample is free and arrives in 24 to 48 hours.
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BUS 551 Module 1 questions, answered
What does BUS 551 Module 1 usually ask for?
Aspen's BUS 551 begins with the goal of the firm and agency theory, so a paper explaining conflicts between owners and managers and how to align them is typical. Check your classroom prompt.
What are agency costs?
Jensen and Meckling defined them as the sum of owners' monitoring costs, managers' bonding costs and the residual loss from decisions that still differ from what owners would choose.
Why is shareholder value the usual financial goal?
Because the value of shares reflects all expected future cash flows and their risk, it rewards long-term decisions rather than short-term earnings.
Where can I find a free BUS 551 Module 1 sample paper?
The full paper is posted above: a family valve maker hiring an outside CEO, with agency costs, research on pay as an agency problem, a compensation table and board monitoring.
Can executive pay create agency problems?
Yes. Bebchuk and Fried found that executives often shape their own packages, so pay can rise without a close link to results.