Agency conflicts mean the issues that arise from allowing executive directors to manage the company on behalf of the shareholders. Most agency conflicts problems in corporate governance are financial in nature. Executive directors and senior managers want to provide enough remuneration for themselves because of the efforts they put into the company. Also, the shareholders require the directors to pay dividends and ensure strategies that will result in an increase in share price.
Why are shareholders at a disadvantage?
Although they invested their hard-earned money into the company, shareholders have little knowledge about the entity compared to the directors. They rely on the audited financial reports, trends in share prices, and the reputation of the directors in making investment decisions.
However, the directors know what is happening in the company before the information is publicized. As a result, they can use such information to their benefit. More so, directors can make decisions in their best interest, rather than the company's and its shareholders' interest.
The Agency conflicts
Pursuit of growth/profit
Directors might decide to focus on long-term growth or short-term profitability. If long-term growth is the focus, they may likely invest in capital expenditure that has a low return on investment. This will hurt the company's share price. Also, if the directors pursue short-term profit, the shareholders will earn dividends now but at the expense of the future company growth.
Lack of work motivation
Executive and senior managers will work less or reduce their motivation to work if their remuneration is not tied to profit and variable sources. More so, if executive directors are given more incentives than senior managers, the managers will have little motive to work. This will affect profit and share price resulting in an agency conflict.
Timing of future goals
The company's directors might have short-term profit goals, to earn more remuneration, and disregard or pay little attention to long-term goals. Short-term profitability means paying dividends, but growth investors are more concerned with long-term return on investment that adds value to the company. The timing issue is that the future goal for shareholders and directors may be on a parallel line.
Job Hazard
Directors face job hazards. As a result of their role, they may encounter people who do not mean well for them. As a result, executive directors want more security in their jobs. They may request to stay in high-brow areas that are more secure, have security guards, and travel in private jets and yachts. This is an additional cost and lower profit to the company at the expense of the shareholders.
Risk-averse/taking
Job security is another important area where there are agency conflicts. Executives and senior management staff may want to be risk-averse,. Still, theshareholders will prefer a company that takes risks to have a higher return on their investment if the company succeeds in taking huge risks. For directors, securing their jobs is paramount; therefore, they will want to be risk-averse.
In conclusion, the agency conflict in corporate governance explains why directors (the agents) and shareholders (the principals) fail to agree in some areas of business growth and sustainability. What shareholders may want the business to do might be different from the directors. This has resulted in agency costs that will be discussed in the next article.
Post a Comment