Management and Shareholder agency problem in corporate governance
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Introduction
In the world of business today, corporate governance has been of great importance for the starting small business and also for the already large established firms. This corporate governance is essential in a business since it makes a company operate more efficiently. It also helps the company mitigate problems and safeguard stakeholders. Through its importance, it prevents the company from corporate scandals, fraud and also prevents criminal liability of the company, among other functions. According to Ojo ( 2014 ), this corporate governance faces many agency problems like the principal-agent agency problem, principal-principal, and the last and not least is principal-creditor agency problems. These agency problems prevent corporate governance from exercising its mandate in the companies effectively. This essay will discuss issues of principal-agent agency and various ways that can be put into place to help mitigate the problem.
Discussion
The principal-agent agency problem involves the shareholders who are active principals and management, which is the passive agent. This shareholder- management collaboration occurs when the shareholders who are the real owners of the company finds it challenging to manage the firm by themselves either because of its large size and they decide to elect a board of directors who oversees the firm on their behalf (Qinin and Jones, 1995). This association creates our first problem facing the shareholders and the management, which is a conflict of interest. Once the shareholders are unable to effectively manage the company and involve the managers in the firm, the managers begin to have their stakes in the company and forego the interests of the shareholders. This problem of conflict of interest occurs when the agent who is the management acts on their interests and ignores the interests of shareholders to maximizing on wealth ( Fluck, 1999). This problem limits corporate governance from fully exercising its mandate on the company, and this causes failure in the company since the company’s profits are not utilized in the best way possible.
In solving this problem of conflict of interest between the two parties, corporate governance should encourage the managers to act on the benefit of shareholders. To achieve this, they should increase the performance-based incentive plan. They can also use threats of firing to any manager who is not acting on the interest of shareholders or even threat to take over the company if no change is done. In solving this problem, an agent compensation strategy should be employed where the agent is only compensated upon the evaluation of his or her performance. This compensation can involve various methods like stock options, profit-sharing, or even deferred compensation methods. If these ideas are put into consideration, conflict of interests between the shareholders and management will reduce effectively.
According to Shao, Kwok, and Guedhami (2010), asymmetric information between the agent and the principal is yet another problem facing the principal-agent agency. This problem arises because the agents have more information unlike the principals like for instance, the agents have more information on potential wealth transfers from the debt instrument holders to stockholders through the acceptance of high risk and high return projects by managers (Alao, 2018). This difference in information can be very harmful to the company since the owners do not understand more about the terms used by the managers. This problem results in corporate governance issues. To mitigate this problem, contract design will be of help, which will create a contract framework between the shareholder and management, thus solving the issue of information asymmetry. This contract design will also stimulate the agent’s incentives to act in the interest of the principal and will also help determine the monitoring procedures.
Moral hazards are yet another problem that faces the principal-agent. This problem results from the asymmetry of information between the two parties. The moral hazard involves a person who is insulated from a particular risk behaves differently from how he or she would have reacted if fully exposed to the risk (Huddart, 1993). In the principal-agent association, this problem arises because of the difference in objectives between the two parties. Because of the difference in goals, the managers may fail to implement the investment despite knowing the effect and harm it may bring to the company. To circumvent this problem, the shareholders and managers should critically evaluate the best objectives that they think will be of great importance towards the company’s growth and act accordingly towards achieving the set common goals. This will help solve the problem that leads to destruction and limits the progress of the company. Through this, the shareholder-management problem will have resolved, and the company will flourish.
Another problem affecting the principal-agent association in corporate governance is the retention of profits by the management. This occurs where after the company’s project and services go through, and huge profits are made, the administration retains the benefits instead of distributing them to the shareholders (Hediger, 2010). This makes the shareholders pull out of the company since they are not benefiting from the company, and they are not attaining their primary aim of investing in the company of maximizing the profits. In solving this problem, the managers should be forced to act on the interest of shareholders by either threatening to fire them or by direct intervention by the institutional investors. This strategy will make managers be scared of since they are not ready to lose their jobs hence solving the problem. The company can also come up with a way of appreciating and rewarding the managers by increasing their salaries.
A desire for best managers by the shareholder is another aspect that brings about the principal-agent problem. This is brought about by the shareholders who want to have the best managers in their company, but they are not ready to pay any more than they have to. They don’t consider the fact that the better the service, the better the pay and nothing good comes from the blue. As a result of this desire, the shareholders force the managers to offer more than they are paid for, and this results in conflict. The more money that managers make in wages and benefits, the fewer shareholders see in the bottom-line net income. In most companies, you find that the top managers set their salaries and also their compensation packages. To deal with this issue, public business corporations should establish a compensation committee that consists of outside directors who should set wages, compensations for the managers, among others, and this will help solve the problem of what salary the bins should be paid in the company. To circumvent this problem, the company should pay its managers well enough based on the service delivered on the basis that, the good the service, the best the pay. This idea will help prevent any conflict that can arise between these two parties with payment and service delivery.
Another aspect causing the principal-agent problem is when the company becomes too critical and significant to the economy, and this makes the shareholders and management feel that the company is too big to fail. This will make the agents have a low incentive on what they do since they know they won’t be having any blame ay the end and that the government will bail them out. For example, during the great recession, the American government bailed out various companies like the JP Morgan Chase. This decision by the government makes the large companies not fully operate to the best, and this increases the problem between shareholders and managers. To circumvent this problem, the government should not bail out any company, and this will help the company’s management and shareholder work hand in hand in order to improve the company’s status, and this will solve the problem.
Corporate governance, on its own, is a factor causing the shareholder-management problem. It affects the development and functioning of capital markets and has a great influence on resource allocation (Lee and Yeh, 2004). It also impacts the behavior and performance of a company, including its entrepreneurship. This interferes with the shareholder-management activities regarding the company, thus creating a principal-agent problem and entirely affecting the progress of the company. This is influenced by the solid corporate policy that corporate governance impacts on a given company. To go through this problem, the company should change rules and put up its own policies that corporate governance cannot meander around with. This will ensure a good shareholder-management relationship that will lead to faster growth of the company, and the company will be in a position to contribute to the country’s economy in one way or the other.
Managers in the company may give away the corporate earning to their favorite charitable institutions, mainly for their glory and personal satisfaction. These managers practice poison pill, where they pose the company as unattractive so as to be taken over or even practice repurchasing of shares from the person trying to gain control of the firm so as to prevent hostile take- over. To prevent this problem, the company should closely monitor their managers’ moves in terms of their charitable offer to various institutions and dug down to know the reason behind it and ensure their offer is out of good faith and not on the basis of bringing failure into the company.
The question of who should control the business between the shareholder and the management brings about the problem of principal-agency. This comes along where the managers who have been employed for their competence and are intimately familiar with the business or the shareholders who have no relevant experience for running the business, but their money is what makes a business tick. This brings confusion about who should control the company. To solve this problem, both parties should respect each other contributions to the company, and this will help solve the problem. Clear directives and policies about the leadership should also be put straight to avoid the confusion of who to lead and who not to and what leading in the company will entail.
Higher taxes imposed on the company affect the shareholder, and this influences the management of the company. The shareholders’ desire minimized taxes more as opposed to the maximization of shareholder wealth. The management teams exploit this by setting salaries that are in excess compared to the industrial norms. This affects the relationship between the management and shareholders, thus leading to the principal-agency problem in corporate governance. In solving this problem, the company should ensure lower taxes are imposed on the shareholders through the policies of corporate governance. Control of debt and equity is yet another problem that results in principal-agent problems. This is facilitated by the management teams who alter the capital structure by employing the debt and equity mix in the financial sector. This preserves a level of control rather than a mix that maximizes wealth for their shareholders. This idea causes the problem of principal-agency, and to circumvent through this, policies should be made to deal with the control of debt and equity effectively.
Capital for the company has caused a problem between the shareholders and its investors, where the shareholders view excess cash on the company’s balance sheet and agitate for its return to shareholders in the form of cash dividends or through the purchase of shares that boost stock values. The investors are limited by the shareholders to invest in new projects since they view this as a threat and the company issuing new shares can dilute the already existing shareholders’ stakes, and issuing of debt, on the other hand, can also increase leverage risk and therefore increases the risk of the company’s stock. These threats impact the management and interfere with the management’ s ability to run and maintain the company or the organization effectively. To circumvent this problem, the company should ensure that the company’s capital and debts are regulated effectively and that the investors are well taken care of by the shareholders to help prevent them from investing in other new investments that are outside their own company. This solution will also be of help in restoring the shareholder-management association, and the good relationship will help the company grow so fast and in a short period of time, and the company will stand firmly and be in a better position to compete against their rivals.
Conclusion
Good interaction between the principal and agent in the business field should be of the best quality. This is because these two parties participate greatly in enhancing the company’s progress. It has been proved that the shareholder-management agency, as one of the agencies in corporate governance, has been faced with various problems. These problems, for instance, conflict of interest, has been seen to have negative impacts on the growth of the company where the managers go against the interests of their shareholders but instead focus on their own interests, and this has brought a lot of problems in the corporate governance of the company. Asymmetric information between the management and shareholders has proved to be a great source of the principal-agent problem in the company, and this should be addressed where the shareholders should get more information and get educated on the basics of business in order to have equal or less equal to the management. Corporate governance despite being good for the growth of any business, it has also been noticed that this corporate governance also has a cause to the principal-agent association where it has solid corporate policies that limit the roles of the managers and shareholders affecting the growth of the company. Profits gotten from the company should not be retained by the management but should be distributed to the right people who are the shareholders, but to balance the equation, the managers should have an increase in their salaries. If the suggested ideas of going along the problems that result in the principal-agent problem are followed to the latter, the shareholder-management agency will be avoided, thus preventing the problems and effects that result from a problem.
References
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