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The Agency Costs of Overvalued Equity and the Current State of Corporate Finance
Author(s) -
Jensen Michael C.
Publication year - 2004
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1354-7798.2004.00265.x
Subject(s) - equity (law) , business review , citation , agency (philosophy) , management , administration (probate law) , corporate finance , economics , accounting , finance , political science , library science , sociology , law , computer science , social science
1. The current malaise in corporate finance My intention today is to provide a way to understand some of what’s currently happening in the world of finance and corporate governance at this time (June 2002). Few if any of us have discussed with our students the consequences of a company’s stock price becoming overvalued. Indeed I know of nowhere in the finance literature where the problems associated with overvaluation are discussed. We talked for a long time in the 1980s about the effects of under-valuation, and I will have a little to say about that below. But as things have progressed over the last half-dozen years overvaluation has come increasingly to occupy my thoughts. Indeed, understanding the incentive and organisational effects of stock overvaluation will help us understand much about the current malaise in corporate finance and corporate governance that surrounds the events at Enron, WorldCom, Xerox, and many other companies. I will review this situation briefly, and then move on to consider the agency costs of undervalued and overvalued equity. For the most part I’m going to concentrate on the latter, and examine the necessity for managers to manage stock prices down in situations where they become substantially overvalued, and the requirement for us to have new language to enable managers and boards to deal with these issues. I will conclude by considering how we solve this, where we go from here, and what’s likely to happen? In most crises like the current one what we usually get from governmental reaction is bad regulation and bad laws. However, in preparing this address I found myself fairly optimistic that things are more likely to move in the right direction. Yet, there is a danger that with the frenzy that is going on now as the result of WorldCom’s announcement earlier this week of its $3.8 billion accounting blunder, Enron’s cooking the books and today’s announcement by Xerox of its $3 billion ‘accounting error’, we may be off and running again to generate damaging regulatory actions. We are all aware of the trillions of dollars of losses that have occurred in the technology, telecom, and dot.com boom and busts, not to mention many bankruptcies,