Agency Theory a

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Module Title: Finance Principles

Module Code: 5AC002

Module Leader:
William Coffie

Student Name and Number:
Qianhui MA(1223583)

Date of Submission: 14th Jan 2013
Words: 1441

Agency Theory and Corporate Governance

Introduction

In 26th February 1995, the Barings Bank, one of the oldest banks of the United Kingdom was declared bankrupt. Nick Leeson, the trader of the bank in Singapore had lost $1.4 billion on derivatives trading while the bank reported capital was only about $600 million. The Bank of England had to close Barings, also known as the Queen's bank since it was used by Elizabeth II. Barings Shareholders lost $1 billion. The Barings Bank collapse is an example of what can go wrong when a bank fails to properly supervise its employees and their trading practices (Wiley 2010). It had shown the significant role of managers and shareholders. The reason for the bank bankrupt is the shareholder mismanagement and the manager overconfidence.

Accordingly, the purpose of this essay is analyzed the agency theory and corporate governance in the company. It mainly consists two sections to conduct analysis. The first section contains the relationship between the shareholders and the managers of the firm (Block and Hirt 2008). And the second one is exploring the corporate governance has become vital corporate issue that needs to be effectively addressed (Singh and Davidson 2001; McKnight and Weir 2009; and Ward and Filatotchev 2009).

Main section

As cited by Cheffines and Bank (2009), the foundation of agency theory could go back to Berle and Means (1932) and Fama and Jensen (1983a). Their studies discuss the notion of the separation of corporation’s owners (principals) and its manager (agents) which is due to the fact that the owners delegate their responsibilities for control to managers who will actually manage the company. Thus the separation between the functions of decision and control will generate conflicts of interest and a series of agency problems between owners and managers.

Indeed, Jensen and Meckling (1976) brought out the agent may be able to undertake actions that go against the interests of the principal. In other words, the managers may pursue strategies which will maximise their own interests instead of those are benefit for owners or the entire company. Therefore, as summarised by Shleifer and Vishny (1997), the existence of agency conflicts between owners and managers who control corporate resources has led to emerging issues of governance mechanisms ensuring that owners’ funds are not expropriated or wasted on unattractive projects. In this case, Nick had made a plenty of profit of the bank, this made the senior management had lots trust in him and gave him progressively full firing power. In the later investment, Nick made decision by himself without telling the shareholders.

Particularly, regarding widely dispersed shareholding, relevant literatures on agency problems suggest that the challenge for this ownership structure is it may not provide adequate control to the owners due to the limitation of capacity and motivation to monitor the behaviour of dominating managers and their management decisions (Jensen and Meckling, 1976; Wellalage and Locke, 2011). Thus the control of the corporations which have diffuse shareholdings reverts to understand dealings in order to augment their income. And the preferences regarding their strategies will often involve a trade-off between the pursuit of shareholder values, orientation and other goals (Thomsen and Pedersen, 1997).

Consequently, the prior studies have explained the emergence of agency problems is attributed to the separation of corporation’s owners and its management. The separation between them will generate conflicts of interest not only between owners and managers but also within controlling shareholders and minority shareholders. With the concentration of ownership structure more dispersed, the gap tends to...
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