Principals-Agents' Conflict of Interest

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Cynthia Claude
Nkono Moanang
1009040

CORPORATE GOVERNANCE AND BUSINESS ETHICS ASSIGNMENT

TOPIC: Principals (shareholders) – agent (managers) problem represents the conflict of interest between management and owners. For example, if shareholders cannot effectively monitor the managers’ behaviour, then managers may be tempted to use the firm’s assets for their own ends, all at the expenses of shareholders. Discuss the pros and cons of this statement with regard to duties of Board of Directors.

Most organisations these days are no more owned by their managers. This separation of ownership and management gives rise to what is called agency relationship. Jensen and Meckling (1976) define the agency relationship as “a contract under which one party (the principal) engages another party (agent) to perform the some services on their behalf. As part of this, the principal will delegate some decision making authority to the agent “. However, it is important to mention that this relationship is not always peaceful and harmonious; rather, it usually raises some agency problems commonly called conflict of interests between shareholders and managers of the company. These conflicts occur when a person i.e. the manager has an obligation not to act in his own personal interest but in another person’s interest i.e. the shareholders. This means that in whatever situation, managers must prioritise shareholders’ benefits. But is this commitment always respected in principals-agents relationships? Hopefully, between these two groups, is the board of directors; directors who are elected by shareholders to act as their representatives by monitoring and controlling managers tasks and ensuring they are in line with shareholders’ expectations. With clear evidence that conflicts of interest are almost unavoidable in any agency relationships, an attempt will be made will be made to get an insight into that issue with regards to board of directors duties.

Brennan (1994) states that “ agency problems emanate from the arrangement where the interests of the agents differ substantially from those of the principals because of the impossibility of perfectly contracting for every possible action of the agents whose decisions affect both his welfare and the welfare of the principal “. Therefore, this raises the issue of finding ways to motivate managers to solely act in the best interest of shareholders. However, in a world where the labour market is becoming more and more imperfect and competitive, managers will be more concerned with their personal benefits at the expense of shareholders’ benefits. Since they are the one taking care of the day-to-day activities of the company, they know better than anyone any single details about how the various tasks are being performed and how that affects the company. Therefore, they might be tempted to take advantage of that by consuming some of the organisation’s resources in the form of lavish perquisites such as airplanes. Agency conflicts imply that shareholders wealth maximisation is being subordinated in managers’ goals for the company. Clear evidence of this assumption could be that top level managers are more worried about increasing their salaries, raising their status within the company, creating more opportunities for lower managers or assuring their job security and to achieve all this, their main objective could rather be to enlarge the firm by creating more subsidiaries. Such an action could produce results that do not necessarily maximise the value of the organisation for shareholders, rather, management welfare. We can notice that in conflict of interest, agents are mostly interested in achieving objectives that they feel will be profitable to them, but which are not necessarily or directly for the sake of shareholders. This occurs as a result of the distance created between the shareholders and the management team which prevent the former to effectively...
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