CASE STUDY 1

(a) Agency cost is a loss incurred which typically arises when the interests of the owners of the
company are not aligned with those of the management or the board of directors. In this case,
the recent board changes would cause an increase in agency costs that will be incurred by
Sentosa House (Sonia) and other investors. The increased in agency costs will be the monitoring
and bonding costs due to the following problems:
(1) insufficient number non-executive directors because of Eastern’s non-compliance with the
stock market requirement;
(2) the investor relations department showing uninformed behavior;
(3) the arrogance of the chairman as well as its credibility, which was shown when he (Thomas
Hoo) could not provide a well-grounded explanation for the concerns addressed by Sonia; and
(4) the pursuit of strategies which was deemed as ‘very risky’, and that no risk committee would
evaluate these strategies employed.
These problems necessitate the reinforcement of monitoring and bonding costs to align the
interests of both shareholders and the board. Otherwise, inaction might force Sentosa House to
sell its holding.
(b) Sonia has no doubt started to be suspicious of the competence of the board in the
management of the company, and the presence of risk committee made up of non-executive
directors (NEDs) could elevate her confidence because of the valuable contributions that they
could provide. In the first place, the risk committee itself would be working on strategies with
minimum risks as possible; more so could be done if the committee would be made up of
independent, non-executive directors. Having the NED's inside the company is particularly
useful in filling up the knowledge gap between the shareholders and the board while at the
same time serves as counterweight with respect to their conflict of interests. This is possible
since the NEDs are not employees and hence, they have no direct interest to the company.
Furthermore, the competence of the chairman (Thomas Hoo) would be recognized, and the
committee will bring it on scrutiny, especially the wisdom on his ‘very risky’ strategies.