We have explained that the corporate governance agency cost resolves the conflict of interest between directors and shareholders. To further solve this agency conflict, the company must align the directors' goals with those of the shareholders. This is achieved as follows:
1. Ensure Independent directors dominance
The company's decision-making should not be dominated by the chief executive officer or the chairman. If this happens, the CEO or chairman will make selfish decisions. Therefore, there should be a board of Independent directors that dominates decision-making.
Independent Non-Executive directors (NED) are expected to monitor the powers of the CEO/Chairman. Decisions should be objective and agreed upon by all members of the board of directors or at least more than half of the members.
There should be a Senior Independent Director (SID) whose goal is to protect the interests of the shareholders. Therefore, when the chairman of the board makes decisions that are not in the best interest of the company and shareholders, the SID steps up to protect shareholders' interests.
2. Use of debt capital
Another way to reduce the agency problem is debt capital. Generally, debt capital is known to reduce taxes paid by the company. But that's not all! It can be used to discourage senior executive managers from investing in projects that may not yield positive net present value.
Top management wants the company to have the highest market share. Therefore, they may focus on spending the company's resources on projects. These projects include investments in capital expenditure and mergers and acquisitions. However, such investments do not translate to profit immediately. Value shareholders may not receive dividends from the company when the current financial year ends.
Debt funding can be used to remedy this problem. When the executive directors know they will repay debt interest and principal, it will push them to focus on profitability and less on expansion.
3. The use of a remuneration package
The remuneration package helps to align executive management objectives with those of shareholders. Most remuneration packages include share options for the directors. As a result, top-level managers will focus on dividend growth and an increase in share price, to benefit from the share options.
To achieve this, board members involved in setting up remuneration set up fixed and variable income plans for the executives. The variable salary plan (including share options) is tied to achieving specific performance obligations for the company such as an increase in earnings per share and total shareholder return (TSR).
In conclusion, to remedy the agency conflict, the company engaged in various activities, including agency costs (explained in a previous article), and the above remedies to align the interests of directors with those of shareholders.
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