04. Agency And Stakeholders Flashcards
What is corporate governance?
The system by which business corporations are directed and controlled.
Ie make sure she directors are acting in the best interests of the shareholders and other stakeholders.
Outline the agency theory.
Duties and conflicts that occur between parties who have a relationship in which one or more persons (the principals) delegate some decision-making authority to another person (the agency) in order for the agent to perform some service on behalf of the principals.
Define the following terms:
- agents and principals
- agency
- agency costs
- residual loss
- accountability
- fiduciary duty
- Agents and principals - an agent is an individual hired or employed by another, the principal, to carry out a task on the principal’s behalf.
- Agency - the relationship between the principal and the agent.
- Agency costs - the costs incurred in establishing and monitoring the agent by the principal (ie how the shareholder controls and verifies management’s activities).
- Residual loss - the reduction in shareholder value that results from excessive agency costs. For example, directors awarding themselves other benefits beyond basic salaries and incentive schemes such as company cars, houses, planes, club memberships etc.
- Accountability - under the agency relationship, the agent is accountable to the principal for the outcome of the work the agent carries out and the resources used. In theory, the directors (the agents) are answerable to, and held responsible by, the shareholders (the principals) for their actions.
Fiduciary duty - involved actions taken in the best interests of another person or entity. It includes duty of care, loyalty, good faith, confidentiality, prudence and disclosure.
Outline the agency problem.
Concerns how the shareholders (principals) control the directors (agents) to ensure that the agents act in the principals’ best interests and not their own.
Consider how the separation of ownership and control has led to conflicts of interests ie divergent interests.
Give some examples of potential conflicts between principals and agents.
- High salaries, benefits and easy-to-obtain bonuses (regardless of performance).
- Excessive retirement benefits.
- Long-term contracts (making it difficult and costly to dismiss directors).
- Golden parachutes - provide directs with significant compensation in the event of a takeover.
- Poison pills - making a takeover difficult when it would be in shareholders interests but not director’s interests.
- Non-business use of corporate assets.
- Related party transactions which are not at arm’s length (parties should be independent and on equal-footing).
Agency theory assumes that it’s costly and difficult for the principal to verify what the agency is doing. According to Jill Solomon, 2007, what are the costs that comprise the total agency cost?
- Monitoring expenses - include costs of having a board who acts on behalf of shareholders and restricts management’s activities (performance-based contracts) and the costs of issuing financial statements (eg audit fees). It also includes cost of NEDs.
- Bonding (contracting) costs - costs of the agents to show the principals that they have acted in good faith eg FS, websites and meetings with institutional investors. Also includes costs of stock options and structures which incentivise agents to act on principals’ behalf.
- Residual costs
Outline possible solutions to aligning director and shareholder interests.
- Incentive schemes - remuneration levels, bonuses and share options.
- Active participation in AGMs - votes are ineffective if fragmented but consider large institutional investors.
- Board composition - NEDs…reappointment of directors.
- Shareholder resolutions - what is discussed at AGMs.
- Selling shareholdings - can trigger takeover bid
- One-to-one meetings - institutional investors. Insider trading?
Stakeholders include anyone who can be affected by an organisations objectives. Donaldson and Preston 1995 suggest two motivations for companies to respond to stakeholder concerns, these are:
- Instrumental approach - stakeholder management is a means to an end, company has to do it to max wealth. Concerns of stakeholders are only considered for strategic value eg not losing customer or retaining staff. Interest is therefore instrumental.
- Normative (intrinsic) approach - company has fundamental principles not just based on what is best for the company. these principles consider how it will take account of the concerns and opinions of others. stakeholder interests have intrinsic worth as their claims are based on fundamental principles
Define business risk and stakeholder risk.
- Business risk - business nah achieve its objectives
- Stakeholder risk - nah max wealth because it doh understand the impact of its stakeholders
Outline the components of mendelows matrix.
Mendelows said you can influence of stakeholders on key strategic decisions can be mapped by looking at two aspects of their relationship with the org:
Power (ability to influence) and interest (how much they care to influence).
- High interest, high power - key players.
Most attention. Difficulty is satisfy different types of stakeholders in this category. - Low interest, low power - minimal effort.
Ignore them but from ethical standpoint they may cause issues later if their power increases. - High interest, low power - keep informed.
Do not underestimate, may form lobby groups or join forces to form stronger grouping and become key players. - Low interest, high power - keep satisfied.
Sleeping giants. Keep satisfied so they stay dormant. If woken up, they can become key players and frustrate adoption of new strategies. Org can make them more interested to utilise their power.
Identify uses of mendelows matrix.
Orgs can:
1. Understand if current strategy aligns with stakeholders’ interests and power.
2. Identify who will support a strategic project and who can, and aim, to stop it.
3. Try to reposition stakeholders to increase support/reduce threats to a strategic objective.
4. Encourage stakeholders to stay in a category or prevent them from moving to another.
5. Identify change within stakeholders that may imply that the current strategy needs to be re-thought with the possibility of a new strategy being developed.
Who are internal stakeholders?
Individuals or groups, who are directly and/or financially involved in the organisation.
E.g. directors and employees
Distinguish between EDs and NEDs.
Executive directors - manage the business on a full-time basis.
Non-executive directors - oversee and monitor the executive directors.
Who are connected stakeholders?
They may have an indirect financial stake in the organisation, and are affected by the organisation’s operations.
Eg shareholders, customers and suppliers, creditors
What and who are External stakeholders?
These have no direct financial stake in the organisation, but are indirectly influenced by the organisation’s objectives.
Eg trade unions, external auditors, regulators, government
