Through understanding of the nature of corporate governance, we also get to understand the vital role that leader of the companies should play. Almost all organizations are directed by board of directors who are either appointed or elected by other board members. They are the primary direct stakeholder influencing corporate governance and are usually tasked with making important decisions of the company such as appointing corporate officers, executive compensation and dividend policy (TECHINCAL, 2012). There is no definite method in defining how many directors a company should have but they are usually determined by an organization’s bylaws (Investopedia, n.d.). They also set the number of board members in the company, the way the boards are elected and how often the board should meet. There are two types of representative for board of directors: A CEO, person who works on a day to day basis for the company; and the other representative encompasses outside directors which are chosen externally and are independent from the company (Investopedia, n.d.).
Governance practice plays a vital role to keep any company in an order by having a balanced system of control and making sure there are no misuse of the power by the people in high positions. Good Corporate Governance practices also assures a long term positive corporate performances (Cooper, 2014) however, same set of governance practice doesn’t work for every companies so every company should implement their own practices to suit their needs. There have been some cases of corporate scandals where they fail to show all the necessary information and cause financial fraud; some intentionally whereas some are unintentional. This is an important issue to consider as investors are more concerned with their investment and the corporates are also losing public trust. Therefore, this essay will attempt to explain the agency problems occurring in corporate business and measures on how they could be reduced.
The relationship between the managers and the shareholder is a key to keeping a healthy work environment in a company (Onetto, 2007). The agency problems start to occur when there is a conflict of interest between the two parties involved. Enron scandal is a well-known example that occurred due to a failed relation among the managers and the stakeholders (Beth Arnold, 2004). As a good governance practice states that the managers should act in the best interest of the shareholders (Cri?an-Mitra, n.d.), the main reason Enron went into bankruptcy is that the manager went against the practice and took their interest as a main priority. Similarly, “Time Horizon” is considered another agency problem where again managers make their interest the priority (jerzemowska, 2006). They look for a short-term reward for themselves and not care about the long-term consequences that might bring to the companies as they won’t be there when it is time to face the consequences. The decision involving the dividend pay-outs and risk aversion can also be another cause of conflict between the managers and the shareholder (jerzemowska, 2006). The managers of any company aim to make decisions with the best interest of their shareholder in mind or to maximise the interest of shareholders. However, the managers prefer to lower the risk of any project even if it affects the shareholder financially whereas it’s the opposite for the shareholders. All these conflicts could be reduced by taking some steps to make sure there is enough communication between the managers and the shareholders and in a way, both of their best interest is considered; all the work done by the managers are being recognized and they are getting rewarded for their effort.
Through much research, (Tamer Elshandidy, 2015), supported the idea that larger board size is more effective in reducing the company problems and high proportion of non-executive directors and independent non-executive directors tend to reduce the agency conflicts. Therefore, reducing the information asymmetry between the managers and shareholders. Information asymmetry can be reduced with improved communication between the involved party. Similarly, If the board has greater independence, there was reduction in the information asymmetry (BENG WEE GOH, 2016). Moreover, this resulted in greater voluntary risk disclosure to the investors also gaining their trust. The change in Board structure also seemed to have an effect in the information environment. There are two board structure: Unitary board structure and the Dual or two-tier board system. UK, US and few other countries follows a unitary board structure where all the executive and non-executive directors serve as members of one board of directors. Whereas many countries in Europe follow the dual board system where they separate the Board of Directors.
(Tamer Elshandidy, 2015) described their findings; the relation of board size, board independence, dividend policy, ownership structure, audit quality with the risk disclosure. The author stated that the high rate of corporate disclosing their risk information mandatorily to the investors is the result of positive implementation on the corporate governance characteristics. It shows how the work environment affects the mind-set of the employees.
Transparent relation between the shareholders and the company is vital to decrease any conflict in the future (Cri?an-Mitra, n.d.). It will allow the shareholders to have more trust and the process to make decision would be fair. The investors also want to have a fair treatment so they prefer a transparent information before investing in any company. However, it is said that many companies in India is family owned businesses thus majority of the independent directors and even the succession of that company would be a family member (Meghna Rishi, 2011). This result in lack of transparency with the other shareholders who were not part of their family. Satyam Computer Services Limited scandal in India can be taken as an example as the founder attempted to hide the deal with a company related to his family by creating false assets in the balance sheet (Meghna Rishi, 2011). Many suspicious things were done by the founder at that time however, they were overlooked by the independent directors as they were in the minority. Whereas, they should be encouraged to actively engage in the affair of the company and voice their own opinion.
Enron scandal comes up as one of the most shocking scandal where they manipulated the accounting information and hid millions of debts from their record, fooling the investors into thinking they were a stable company. Enron used the “mark-to-market” principle (Beth Arnold, 2004). “Mark-to-market” also known as MTM principle is when value of an asset is updated to its current market levels (Amadeo, 2016). The company broke many governance practices and took advantages of many loopholes, avoided paying taxes and many more.
As we looked at the causes of agency problems, it is imperative to say that to reduce the agency problems, effective monitoring of the managerial actions should be carried by the independent directors which can result in improved quality of information provided (Tamer Elshandidy, 2015) and might also improve the relationship of the shareholders and the managers. The idea to let the managers be involved with the company in more depth by rewarding them with equity might help them to stay more motivated (Onetto, 2007) and less likely to cause any conflicts. This can also reduce the chances of “time horizon” problem as their interest will align with the shareholder’s and they will be interested in the company’s long term success. In case of risk aversion, the company could solve the problem by introducing bonuses that are linked with a project which will motivate them to take more risk. Overall, the implementation of good governance practices in any firm is necessary and making sure everyone fully understands them and follows them is vital in reducing any agency problems.
One more thing to note is that as there are many award programmes hosted throughout the year for the different types of companies, the number of awards won by a company alone is not an indication of the company’s achievement (Balaram, 2009) as they might not always be honest. As many scandals that came into light included companies that had gone on to win those awards, they just took advantages of the public trust.