An agency relationship in business terms can be described as a fiduciary relationship between two parties whereby one of the parties is a principle, and the other is an agent representing the principal in transactions with a third party. This relationship occurs when a principal such as a small firm hires an agent to perform services on its behalf
In the case where there is only one employee (the owner), and only his money is invested, agency conflicts will not arise. This is because the owner will not have hired any agent to represent him in his transactions. On the other hand, if the company expands and the owner hires additional people to represent and help him, then, agency conflicts may arise. Some of the agents employed are managers who account for the company to investors. As such, disputes between the agents (managers) and the shareholder (owner) arise. Most of the disputes arise due to the conflict of interests between agents and the shareholders. The agents or the managers may have divergent goals in the sense that while the owner’s goal is to maximize expansion and shareholder value, the agent may be concerned with his or her job security and improving his status in the company regarding power. As such, the agents may be forced to undertake actions that are not in the best interest of the shareholders.
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When the owner sells stocks to outside investors, conflicts between the agents and the new shareholders might arise significantly. In this accord, conflicts such as threats of the agents losing their jobs may occur. Elaborately, the shareholders have the power to intervene in the agent's operations and give directives. If the performance of the agents is not pleasing to the shareholders, they can hold a meeting to elect a new board of directors and decide to fire the underperforming agents thus creating conflict. Additionally, since the stocks have been sold to outside investors, the risk of takeover is increased in case the owner’s stocks are undervalued. This means most agents would lose their jobs which again is a source of conflict.
In the case the company fundraises from outside lenders and invests in a risky new project, then a conflict emerges between the creditors of the company and the borrower. This is because of the uncertainty; the business may be profitable or may lead to bankruptcy. Moreover, if the business fails, the creditors foot the loss. In case the company borrows, issues an additional debt and uses the proceeds to buy the outstanding stock, then the company increases its financial leverage. As such, if the situation turns out to be favorable, then the shareholders gain from the increased leverage. In these situations of increased leverage and assets, stockholders stand a high chance of benefiting at the expense of the creditors.
In the case the owner cashes out and makes the company public leaving him with no controlling shares, then there may exist potential unethical behavior that could harm the value of the enterprise.
The agents or managers may take risks that are too high or too low,
The managers may decide to use corporate resources to indulge in selfish activities that only benefit them rather than the shareholders,
The managers may choose to withhold sensitive and relevant information from the shareholders. This could be detrimental in terms of decision making,
The managers or agents may desist from making tough but correct decisions that could affect or harm their friends in the company,
Maximization of the business value requires effort and time. Consequently, the managers may decide to neither put in effort nor time, and
In the case the company is making profitable free cash flows, an agent may choose to stockpile the cash flows regarding market securities rather than returning them to the investors.
Corporate governance refers to practices or rules that direct and control the business activities of an organization. It involves the balanced making of decisions in the interest of all the stakeholders. Examples include implementation of internal control and corporate disclosures. Provisions include;
Accounting control policy,
Bylaws that provide companies to avoid takeovers,
The capital structure choice which helps avoid conflicts of interests between the stockholders and the lenders,
Directors are responsible for discipline and monitoring, and
Compensation plans will be made in a bid to prevent conflicts of interests between owners and employees.
The board of directors’ role is to monitor activities of the chairman as well as the management in a bid to ensure that the company operates in the best interests of the shareholders. The shareholders of the company do not indulge in the day-to-day activities of the company, and as such, the board of directors is elected.
To effect and deter takeovers, the corporate charter must include the following provisions;
Exclusion of the shareholders’ provisions and rights of the charter to avoid the existing shareholders from buying a specific number of shares at an incredibly low price.
The charter must incorporate limited voting rights to prevent hostile takeovers. As such, this provision hinders shareholders from buying a number of specified shares more than a certain percentage.
Finally, the charter must include restrictions to repurchase of targeted shares through signing the Greenmail document.
Stock options give employees the right to purchase stocks at the exercise price regardless of the market value being higher. Consequently, this harms the business in the sense that it may lead to the falsification of financial statements putting it above its competitors.
Block owners can holistically be described and defined as the outside investors like institutional investors who own huge blocks of stocks. These block owners affect corporate governance through monitoring and influencing the management to act in the interest of the shareholders.
Legal systems and regulatory agencies affect corporate governance through working to protect the interests of the investors. This protection is done via providing a flawless access to the company’s financial statements. In addition, the agencies and legal systems make the market news available and subsequently control the market liquidity, costs of investment, and managing unethical institutions.
