Agency Theory and Corporate Governance

In financial institutions, ethical issues have been described as the bedrock of the reported financial scandals and funds mismanagement we have today and a special case is the 2010 recession also known as the Great recession. The great recession started in December 2007 and lasted till June 2009. It was characterized by massive job loss, increased poverty level, low investment rate, unemployment and so on (Lawrence et al., 2012). According to Argandona (2012), ethical issues that causes financial crisis occurs in two dimensions; personal ethics and organizational ethics.

This article drives into how deep America is corrupt and the rocket scandals. The author attains to explain the current state of managerial capitalism in American big corporation further he describes the fundamental reasons for decay in business ethics in order to meet the bottom line standards. Challahan marks the outcome from day to day business such as auto mechanic services , law officers and corporate executive to prove that always people choose financial stability over integrity .

Corporate governance is a set of actions used to handle the relationship between stakeholders by determining and controlling the strategic direction and performance of the organization. Corporate governance major concern is making sure that the strategic decisions are effective and that it paves the way towards strategic competitiveness. (Hitt, Ireland, Hoskisson, 2017, p. 310). In today’s corporation, the primary objective of corporate governance is to align top-level manager’s and stakeholders interest. That is why corporate governance is involved when there is a conflict of interest between with the owners, managers, and members of the board of directors (Hitt, Ireland, Hoskisson, 2017, p. 310-311).

The Fundamental Agency Problem and Its Mitigation • 3 Early on, three principal approaches were developed to minimize the agency problem. One, the "independence" approach, suggested that boards of directors, comprised to be independent of management, can monitor managers and assure that their interests do not diverge substantially from those of owners (Fama, 1980; Fama & Jensen, 1983a, 1983b; Jensen & Meckling, 1976; Mizruchi, 1983; see also Chandler, 1977). Another method, the "equity" approach, proposed that managers with equity in the firm were more likely to embrace the interests of other equity holders and, accordingly, to direct the firm in their joint interests (Fama & Jensen, 1983b; Jensen & Meckling, 1976). Lastly, there was the notion of the "market for corporate control," which set forth the principle that corporate markets may operate to discipline managers who inappropriately leverage their agency advantage. In such cases, self-serving executives may subject the firm to acquisition by other firms (Fama & Jensen, 1983a; Jensen & Ruback, 1983; Manne, 1965). While these three corporate governance approaches are rational in principle, the efficacy of these approaches in practice remains subject to debate. Accordingly, in subsequent sections of this manuscript, we provide a multidisciplinary overview of agency theory with an emphasis on the three mechanisms through which the fundamental agency

The paper reviews three important theories in corporate governance, different theories using different terminology, and views corporate governance from different perspective. Some articles are used to support these theories in this paper. From the Cadbury Report in 1992, we can get the information that corporate governance is the system by which companies are directed and controlled, which involves a set of relationship between a company’s management, its board, its shareholders and other stakeholders, and the objectives for which the corporation is governed. There are mainly three important theories included in corporate governance, which are agency theory, transaction cost theory and stakeholder theory, each theory views

Corporate Governance is the set of relationships between a company’s shareholders, board, the executive management and other stakeholders. The conflict of interest between these parties has resulted in what is called the agency problem, which arises from the separation of ownership and control at a corporation. Good corporate governance practices attempt to resolve the agency problems by aligning the interests of managers and shareholders. The same corporate governance is not followed by all countries; it differs according to the culture, practices, legal, and history, economic and social environment. Each company follows its own procedure for governing on the lines of the model given by the country. Corporations today have laid down the policies of CG in their own manner as a result of which an important question is whether standard CG can be established and achieved at a global level. In each country, the corporate governance structure has certain characteristics or constituent elements, which distinguish it from structures in other countries. CG component factors can be classified into three groups those related to top management organization, the board as whole or shareholders, and stakeholders.

A potential agency conflict arises whenever the manager of a firm owns less than 100 percent of the firm's common stock. If a firm is a sole proprietorship managed by the owner, the owner-manager will undertake actions to maximize his or her own welfare. The owner-manager will probably measure utility by personal wealth, but may trade off other considerations, such as leisure and perquisites, against personal wealth. If the owner-manager forgoes a portion of his or her ownership by selling some of the firm's stock to outside investors, a potential conflict of interest, called an agency conflict, arises. For example, the owner-manager may prefer a more leisurely lifestyle and not work as vigorously to maximize shareholder wealth, because less of the wealth will now accrue to the owner-manager. In addition, the owner-manager may decide to consume more perquisites, because some of the cost of the consumption of benefits will now be borne by the outside shareholders.

The conflicts during the company operation between the personal goals of the management and the wealth maximisation of the owners may relate the following fields:

In many firms separation of ownership and control is present as the shareholders who run the company often hardly ever get involved in the day to day running of the firm. However this

Managers are hired to act on behalf of the shareholders of a firm. However, this is not always the case as both parties have different objectives. The difference in interests between shareholders and managers ‘derives from the separation of ownership and control in a corporation’ (Berk and DeMarzo, 2011: 921). Whereas shareholders are interested in maximising their own wealth, managers may have more personal interests which differ to that of the shareholders. Downs and Monsen (no date, cited in Chin, Cooley and Monsen, 1968:435) suggest that managers self-interest lies in maximising their life-time income and that ‘such self-interest will be congruent with profit maximisation for the firm only in special cases’. This conflict between both

Under the shareholder model of corporate governance, majority of large firms are controlled by managers but primarily owned by outside shareholders. Development of agency problem occurred, due to this separation of ownership and control between firm’s managers and owners. Even though internal managers are responsible for business operations, shareholder voting rights provide them with some indirect control over the operations of the firm. Widely distributed ownership in shareholder method offers stronger protection for investors and shareholder democracy.

This chapter evaluates the features of disputes related to companies with regard to the Companies Act of 2006. The chapter will also discuss empirical research as well as its findings related to the Companies Act of 2006 coupled with various disputes and arguments related with it. It will include various claims with regard to the nature of such disputes and arguments along with the evidence available. Contemporary literature states that private companies are mostly established based on personal relationships and mutual trust of shareholders. In case there is any breakdown in shareholders’ relationships, then disputes may happen and these are known to be called as “exit disputes”. This literature study will use the term “relational breakdown” to refer to the process of breakdown of relationship of shareholders (V.H., 2008). Given that relational breakdown tends to occur because of various underling factors and these are the main causes of disputes among shareholders of a firm. Relational breakdown also results in opportunistic behaviour on part of most of the shareholders who may attempt to increase their impact on the control of a company by exerting power of majority power hold (V.H., 2008). Additionally, it can be stated that most of the shareholders in a given private company employ an opportunistic conduct by using techniques known as “squeeze out” (Hollington, 2007). Thus, it is crucial to understand the concept of disputes of shareholders to better

Prior researches offer the three main reasons of the conflicts between shareholders and managers. Firstly, managers tend to put emphasise on investing cash flows regarding paying dividends, though this investment do not have much profitable return in the future. This tendency may be caused by the more wages, reputation

The conflict between the principal and the agent is only an effect of a wider problem known as information asymmetry. Information asymmetry occurs in transactions where one party has more or better information than the other and creates an imbalance of power in transactions. Information asymmetry can further intensify the conflict between the principal and the agent. Within a company, asymmetry of information exists between managers (agents) and shareholders (principals). Because managers operate the company on a day-to-day basis, they have access to inside information about management accounting and financial data. Managers may use the confidential information for their own benefits rather than maximize the company’s wealth towards the goal

Firstly we find the “agency theory”, refers to the owners and managers of the companies that have different interests. That is, the shareholders or owners should confront the problems related with managers, who may be acting based on their own interest.