Powers and Duty of Directors in Light of Agency Theory - Literature review Example

Powers and duty of Directors in Light of Agency Theory Corporate governance can be defined as a combination of laws, listing rules, regulations and voluntary private sector practices that enables a company to attract capital, perform efficiently, and meet legal and society objectives and achieve the objectives of the company. In a bid to ensure that the interests of different stakeholders are met, good corporate governance demands that rules and regulations should be put in place to ensure that in the attainment of the company objectives, the interests of the different stakeholders are met without fringing on the desires of any group (Monks & Minow 2004). Agency theory aims at solving the problems that might arise between the various stakeholders of a corporation i.e. conflicting interests of shareholders and board of directors, majority and minority shareholders, shareholders and creditors and even employees and the shareholders (Pitt 2011).. Good corporate governance and company law aims at mitigating the agency costs. Agency theory aims at determining the potential threat principals’ face when the appointed agent fails to act in the manner intended when appointed. The principal is also expected to avoid interfering with the agent in manner that may conflict the execution of the task by the agent. The shareholders of a listed company have the responsibility of appointing the directors of the company during their general meetings. Once appointed, the directors of the company are expected to represent shareholders in the formulation of the company objectives, mission and objectives. The shareholders expects the board of directors to have their interests at heart when making decisions that are intended to influence the way and manner in which the company is operated and managed. This is however not automatically what happens once the board of directors are appointed to the office. In some circumstances, the members of the board fail to make decisions that are aimed at maximizing shareholders rather they begin to put their personal interests the operations of the firm hence resulting into a conflict of interest. Corporate governance and legal requirements of company law aims at reducing and mitigating the costs of such conflicts of interests. In other cases, directors have been faulted for acting on their personal selfish interest that benefits them and disregard the interest of other stakeholders. This paper aims at looking at the whether an increase in the shareholders powers vis-à-vis that of directors is desirable. Agency theory identifies the various forms of conflicts that arises between the various stakeholders. Corporate governance on the other hand aims at coming up with strategies and ways of mitigating the agency costs. Various regulatory bodies have also been designed to ensure that the agency problems are resolved and mitigated by coming up with laws and regulations that guide the way companies are run. Powers and Duties of directors in light of agency theory First the directors have the duty of recruiting, supervising, retaining and compensating the management. The board of directors is charged with the duty to appoint the company chief executive officer or the managing director who will then be mandated with the duty to manage the day today operation of the business. The CEO or the MD will be responsible for the implementation of the strategies and objectives that are set by the board of directors. The board will also ensure that a competent management team is formed to ensure the organizational objectives are achieved. In doing this role the board should ensure that competent persons and talented individuals are given the responsibility band not those who are looking for jobs simply because they are out of jobs. Board of directors must also ensure that they do not develop personal interest of appointing their friends or relatives who are not competent. The board of directors will also have the duty of setting remuneration of the top company officials. The remunerations must be determined in a manner that takes into account the level of experience, skills and market rates. The main board should ensure that the nomination and remuneration committee recommendations are evaluated and adopted if they are reasonable. The role of setting management remuneration will ensure that the agency theory conflict between management and shareholders is avoided so that management does not draw high salaries at the expense of returns available for the shareholders. In doing this role, shareholders powers should be increased to ensure that the appointments are above board and are done within the law. Shareholders should be given the power to question the manner in which the appointments are done and in instances where they believe the process was not meticulous or was overridden by personal interests, shareholders must be allowed to question and receive valid answers (Thomsen 2005). This will ensure that the decisions made by the board are put into scrutiny to avoid laxity on the part of the board. The second duty of the board is that of providing directions for the organization by setting the vision, mission and objectives of the company. In doing this role, the board is assisted by the CEO and the business managers. This role is very important for a company since it determines the manner of investments to be undertaken and sets the timelines and expected returns on such decision. Shareholders powers should not be increased in doing this to avoid delays in decision making and to ensure that there is no interference in the operation of the company. By leaving this duty to the board and top management, the company will benefit from the experience and competence of professionals hence leading into good governance (Benn & Dunphy 2007). The board and the top management of the company must and should share the visions, mission and goals of the company with the shareholders during the general meetings to win their support and to make the owners raise any concerns that they may have regarding the decisions. For instance, where the goals require additional funding, shareholders may do so by approving a rights issue. Another important role of the board is the approval of investments and transactions of huge amounts and special characteristics that makes them strategic to the business. The board of directors are expected to determine and approve major transactions of the company i.e. acquisition decisions that aims at increasing their shareholding in other companies or in acquisition of ownership of other companies. There are however some exceptional instances where the approval of the shareholders is required in making some investments decisions. Some of the decisions that will require the input of the shareholders include decisions of merger and take overs. Merger decisions are core to the shareholders as it may dilute their ownership and control. In addition, the shareholders will be required to approve takeover decisions i.e. where other companies want to take ownership of their company. Increasing the powers of the shareholders with regard to investments decision above their powers elaborated above is uncalled for and will result in conflict of interest. This will place the shareholders at conflict with the management hence affects the company’s performance. It is thus recommended that the directors should have the exclusive duty of determining the investments the company should make except for extraordinary circumstances that may directly and significantly influence shareholders e.g. takeovers (Madan 2012). Moreover, the board has a fiduciary role of protecting the assets and investments of the shareholders. This role requires that the board ensures that the plant, equipment and other assets of the company are well kept and are in good condition. The board further has the responsibility that the assets are put in better use that are aimed at generating revenues to maximize the value of the shareholders (“Corporate Governance” 2002). This role is critical to the company and should not be ceded to the shareholders as it might lead to numerous conflicts. The shareholders should only have the right to question whether the assets are in good condition and are utilized for purposes they are intended for. Another important duty of the board is that of monitoring and ensuring control. Monitoring and control duty of the board involves the duty of engaging the auditors to check and give an opinion on the operations of the company. Once engaged, the auditors should report to the board audit committee their findings and this should be presented to the main board to discuss the auditors findings (Kim & Nofsinger 2007). This is an important role as it determines whether the controls that have been put by the management are sufficient to protect company assets from misuse or loss. The audit will also check whether the company operations is in line with the statutory requirements. Increasing shareholders powers with regard to this role is undesirable and may cause unnecessary wrangles in running the company. The shareholders however must retain their role of approving the appointment of auditors during the annual general meeting. The shareholders also have a right to know the report of the auditors as this is the only way they will be assured that the company is run in the manner they intend and within any stipulated laws (Payne 2010). Shareholders must also be made aware of the audit fees incurred by the company as a disclosure in the notes as required by the company law. This way, the shareholders will be able to assess that the amount paid to the auditors is reasonable and that the objectivity of the auditors is not in any manner impaired or eroded (Thanopoulos 2014). The shareholders should as well continue having the right to question the management and the board on the findings of the auditors especially in instances where a modified opinion is issued. Setting a governance system is also another important duty of the board of directors. The board of directors are required to periodically interact with the managing director and top management of the company as a way of ensuring they are kept informed of the company performance on a quarterly basis. The periodic meetings will enable the board revise their expectations in instances where this is necessary or to change strategy to ensure they survive in the changing business environment (Bauen & Venturi 2009). This may as well be done through conference calls or phone meetings. The number of meetings between the board and the management must however be done as guided by the company law and good corporate governance principles. Directors must avoid unnecessary meetings that are aimed at drawing sitting allowances and other meeting entitlements. Shareholders power in this regard cannot be increased as it will not be prudent or value adding to organize meetings with all the shareholders. It will also be expensive and will boarder interfering with the running of the business hence this must be avoided (Monks & Minow 2004). Shareholders will however be informed in instances where the performance of the company is likely to drop below the level stipulated by the company’s law (Hilb 2005). To help protect the interest of the shareholders and other company stakeholders, company law has specifically stipulated what is expected of directors and some of the things directors are prohibited from doing. For instance company act directly demands that directors should only act within their powers and are not expected to act beyond their powers. For example the law requires the directors to ensure they get approval from the shareholders in cases where they wish to enter into significant transactions that need owners’ approval. The company law further requires directors to act in a way that promotes the company success and not their interest. Directors must therefore act in good faith and in a way that promote the interest of the shareholders i.e. maximizing the value of their investments. The concept further requires that directors consider the long term impact of their decisions, its impact on the company employees, impact on the operations and community and whether their decisions will maintain the reputation of the business. Moreover, directors are expected to exercise reasonable care, skills and diligence in their work. This means that the decisions a director makes should be that which is expected of a different independent person with the same skills, knowledge and experience acting under similar circumstances. In addition, the legislation requires directors to avoid conflict of interest when performing their duties. A director is expected to disclose instances where his personal interest conflicts that of the company. In such instances, the director is expected to disclose such conflict in time and if possible excuse himself from being involved in the process (Bauen & Venturi 2009). A direct must as well not use any information he has by virtue of being a director to further his/her personal interest. Company law further prohibits directors from accepting benefits from third parties by virtue of him being a director this could be in the form of commission a director receives because of negotiating a transaction on behalf of the company (Chambers-Jones 2013). It could also take the form of a bribe a director may receive from third party doing business with the company i.e. bribes from company vendors or gifts are prohibited. The law further prohibits close relatives of directors from participating in tenders or transactions that will be deemed to benefit the director or close relatives. Directors who do not adhere to the provisions of the law commits an offence under the act and may be liable to the company. Directors may be required to compensate the company for any losses realized because of failure to act with due care. In some instances a director may be liable to imprisonment for failure to comply with the legal requirements (Dignam & Lowry 2009). Apart from the company law, companies have also designed their article of association in a manner that is intended to guide directors’ action. Companies’ articles also stipulates that directors must disclose their interests and act in the best interest of the company. It is therefore substantially acceptable to argue that there is no need to increase the powers of the shareholders but instead focus on ensuring that directors act within their scope and adhere to both the legal requirements and other good corporate governance principles (Loose, Griffiths & Impey 2008). The law gives the shareholders the right to appoint directors and the law also require that one third of directors be rotated when their terms expires. These are some of the measures that are intended to make shareholders exercise the option of influencing the manner in which the companies are governed. Directors’’ rotation requirements will further ensure that new blood is injected in this important organ to develop new ideas and come up with new strategies. Instead of demanding more powers, shareholders should remain vigilant to ensure that directors act in the best interest of the company. Giving directors the power to determine the manner in which the company is run will further ensure quick decision making by selected competent and qualified directors. Through this the company fortunes will be enhances and shareholders return will be maximized. It is therefore not desirable to increase shareholders powers as this will result into agency costs because of infringing on other stakeholders right. Giving shareholders more power will as well make it difficult to hold anyone accountable for decisions made by the company. References Bauen, M., & Venturi, S. (2009). Swiss board of directors: organisation, powers, liability, corporate governance. Bruxelles: Bruylant ;. Benn, S., & Dunphy, D. C. (2007). Corporate governance and sustainability: challenges for theory and practice. London: Routledge. Chambers-Jones, C. (2013). John Lowry and Arad Reisberg, Pettets Company Law: Company Law and Corporate Finance. The Law Teacher , 47(1), 121-123. (2002). Corporate Governance Update. Corporate Governance, 10(1), 61-66. Dignam, A. J., & Lowry, J. P. (2009). Company law (5th ed.). Oxford: Oxford University Press. Directors duties and responsibilities. (n.d.). ICAEW Home. 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Global business and corporate governace enviroment, structure, and challenge. New York, NY: Business Expert Press. Thomsen, S. (2005). Corporate governance as a determinant of corporate values. Corporate Governance, 5(4), 10-27. Read More