agency theory

corporate governance

1. CORPORAT GOVERNANCE AGENCY THEORY AYUSHI GUPTA M.COM 1SEM BAM 701

2. OUTLINE INTRODUCTION AGENCY THEORY IMPORTANT TERMS -AGENTS -PRINCIPALS -AGENCY PROBLEM -AGENCY LOSS -AGENCY COST MECHANISM OF THEORY PROBLEMS OF THE THEORY

3. INTRODUCTION CORPORATE GOVERNANCE IS A SYSTEM BY WHICH THE ORGANIZATION IS DIRECTED AND CONTROLLED. THIS STRUCTURE SPECIFIES THE DISTRIBUTION OF RIGHTS AND RESPONSIBILITIES AMONG DIFFERENT PARTICIPANTS IN THE CORPORATION, SUCH AS, THE BOARD, MANAGERS, SHAREHOLDERS AND OTHER STAKEHOLDERS, AND SPELLS OUT THE RULES AND PROCEDURES FOR MAKING DECISIONS ON CORPORATE AFFAIRS. THERE ARE FOUR BROAD THEORIES TO EXPLAIN AND ELUCIDATE CORPORATE GOVERNANCE- AGENCY THEORY STEWARDSHIP THEORY STAKEHOLDER THEORY SOCIOLOGICAL THEORY

4. AGENCY THEORY THIS THEORY IS GIVEN BY ADAM SMITH WHO IDENTIFIED AGENCY PROBLEM (MANAGEMENT NEGLIGENCE AND PROFUSION) IN THE JOINT STOCK COMPANY. THIS THEORY IS BASED ON THE CONCEPT OF SEPERATION OF OWNERSHIP AND CONTROL. AGENCY THEORY IS A BRANCH OF GAME THEORY. THIS THEORY IDENTIFIES THE AGENCY PROBLEM IT SPECIFIES MECHANISMS WHICH REDUCE AGENCY LOSS OCCURRED DUE TO AGENCY PROBLEM

5. AGENCY THEORY

6. IMPORTANT TERMS AGENTS- THESE ARE THE MANAGERS APPOINTED BY THE SHAREHOLDERS, RUN THE COMPANY ON BEHALF OF THE SHAREHOLDERS. PRINCIPALS- THESE ARE THE SHAREHOLDERS, OWNER OF COMPANY DELEGATES WORK/ RESPONSIBILITY TO THE MANAGERS.

7. CONTI…… AGENCY PROBLEM- THE OBJECTIVES OF MANAGER (AGENT) ARE DIFFERENT FROM THE SHAREHOLDERS(PRINCIPAL) THIS CONFLICT IN OBJECTIVE IS AGENCY PROBLEM . SEPARATION OF OWNERSHIP AND CONTROL LEADS TO A POTENTIAL CONFLICT OF INTEREST BETWEEN DIRECTORS AND SHAREHOLDERS . THE AGENTS’ OBJECTIVES (such as a desire for high salary, large bonus and status for a director) WILL DIFFER FROM THE PRINCIPAL’S OBJECTIVES (wealth maximization for shareholders ).

8. AN Agency relationship exists WHEN: Shareholders (Principals) Firm Owners Hire Managers (Agents) Decision Makers which creates Agency Relationship Risk Bearing Specialist (Principal) Managerial Decision-Making Specialist (Agent)

9. CONTI…. AGENCY LOSS- IT IS THE DIFFERENCE BETWEEN THE BEST POSSIBLE OUTCOME FOR THE PRINCIPAL AND THE CONSEQUENCES OF THE ACTS OF THE AGENT. AGENCY COST- THESE ARE THE COSTS BORN BY SHARE HOLDERS TO PREVENT AGENCY PROBLEM WHICH FUTURE RESULT AGENCY LOSS, TO MAXIMIZE OWNERS WEALTH. THEY HAVE TO INCUR 4 TYPES OF COSTS- -MONITORING -BONDING -OPPORTUNITY -STRUCTURING

10. PROBLEMS OF AGENCY THEORY CONTROL OF MANAGEMENT IS NEITHER FEASIBLE NOR REQUIRED. MANAGERS ACT TO OPTIMIZE THEIR PERSONAL PAYOFFS. EXECUTIVES ACT TO PROTECT THEIR STATUS. INFORMATION ASYMMETRY.

11. MECHANISMS THAT HELP TO REDUCE AGENCY COST AND IMPROVE CORPORATE PERFORMANCE – FAIR AND ACCURATE FINANCIAL DISCLOSURE. EFFICIENT BOARD OF DIRECTORS. ACCOUNTING INFORMATION (MONITORING MANAGER PERFORMANCE). CONTRACTUAL OBLIGATIONS. INCENTIVE SCHEMES FOR MANAGERS ( WHICH REWARD THEM FINANCIALLY FOR MAXIMIZING SHAREHOLDER INTERESTS).