Agency Relationship and Conflicts
An agency relationship is a fiduciary relationship between two people or organizations where one party, the agent, acts on behalf of another party, the principal. The acts include managing or conducting business, signing important papers, and the authority to make decisions in the company or business. The relationship is always based on trust between the parties and can be created by ratification, expressed agreement or estoppel.
There are three potential conflicts; conflicts between stockholders and managers, stockholders and lenders, and among stockholders, managers and lenders. No agency conflicts will exist if I am the only employee because there will be no type of any agency relationship. An agency conflict arises when the business manager does not own 100 percent of the business stock or has other agency relationships. Since I am the only employee and only my money is invested in the business, I completely own the business and its operations, 100 percent. Besides, it will be at the start of my operation thus, I will not have borrowed money from lenders or allowed investors to put in their shares in the company.
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Agency costs
Agency costs are expenses accrued by the company or business due to the actions of the shareholders from the agency relationship. Agency costs arise mostly due to dissatisfactions and disruptions, like conflicts of interest between shareholders or lenders and the management. The type of agency costs that might occur suppose my company raises funds from outside lenders is opportunity costs. The opportunity costs will be incurred because the company will acquire funds to expand the businesses and the shareholders will have to invest in specific goals. However, direct agency costs might be accrued from my unnecessary purchase of the yacht and trip to South Pacific for my own pleasures, as it will be of no benefit to the lenders of my company.
Lenders might mitigate the agency costs by securing their loan, and putting in place restrictive rules in the debt agreements. This form of mitigation by the lenders applies when the borrower decides to make poor decisions like risky and unproductive investments, after taking the loan. Lenders can also decide to charge higher interest for the loan than usual, so as to compensate for the potential risks. This will greatly help mitigate the agency costs in the company thus ensuring that funds are appropriately spent by the management.
Corporate Governance
Corporate governance is a system of policies, regulations, practices and rules that direct how the company should operate and be managed. Corporate governance includes the relationships among the board of directors, shareholders, management and other stakeholders. Good corporate governance enables the sustainability of economic development by raising the performance of the company and increasing the number of investors and outside capital. According to Pagano & Volpin (2005), the five corporate governance provisions that are internal to a firm and are under its control include:
1) Directors, workers and management to receive salaries, benefits and reputation, while investors expect to receive financial returns.
2) Specified interest payments for lenders, and returns to equity investors arise from dividend distributions or capital gains on their stock.
3) Customer’s concern about the certainty of the provision of goods and services of an appropriate quality.
4) Supplier’s concern about the compensation for their goods or services, and possible continued trading relationships.
5) Maintenance of the key organizational functions through the managerial supervision and control.
4. Stock Options in Compensation Plan
A Compensation plan is a formal statement that explains a company's plan on employee pay and rewards. It includes information about commissions and incentives that may be paid to employees. Stock options are forms of compensation. They can be granted by companies to the employees and investors for motivation. Stock options give an employee the right to buy or purchase a set number of shares of the company stock at a strike price (Ermel & Medeiros, 2020). The exercise however, has limited number of years. Stock options cannot be exercised for many years.
Some potential problems with stock exchange as a form of compensation includes its loss of value in the market place. Additionally, stock options can influence managers to make false financial statements or take unnecessary risks. Besides, stock options may lead underperformance by some managers.
Effects of Regulatory Agencies and Legal Systems on Corporate Governance
Regulatory agencies and legal systems affect corporate governance in that, companies must abide to the rules and regulations of the areas they are situated (Aguilera, 2018). Regulatory agencies are responsible for ensuring that the appropriate standards, policies, and practices are established, and incorporated, in relation to the corporate governance principles. Besides, Regulators agencies are also responsible for ensuring the protection of shareholders, and allowing management and directors to do their jobs for company growth thus, creating value for shareholders. Company managers and directors have a duty of complying with rules and regulations so as to prevent the violation of legal systems.
References
Aguilera, R. V., Judge, W. Q., & Terjesen, S. A. (2018). Corporate governance deviance. Academy of Management Review , 43 (1), 87-109. https://journals.aom.org/doi/abs/10.5465/amr.2014.0394
Ermel, M. D. A., & Medeiros, V. (2020). Stock-based compensation plan: an analysis of the determinants of its use. Revista Contabilidade & Finanças , 31 (82), 84-98. https://www.scielo.br/scielo.php?pid=S1519-70772020000100084&script=sci_arttext
Pagano M and Volpin P. (2005). Managers, Workers and Corporate Control. The Journal of Finance , 60, 841-868.
