Strategic Management Thinking - Agency Theory - Essay Example

AGENCY THEORY al Affiliation) Key words: Agency theory, C.E.O Introduction The agency theory asserts that theinterests of the shareholder need protection which can be achieved by separating the roles of the chairman, chief executive officer and the board of directors. The stewardship theory on the other hand states that a shareholder’s interests are achieved when the roles are shared among the management (Kulkami 1988). Strategic management thinking coupled with business policy in recent times has been influenced by the agency theory. According to some, the agency theory propagates that unless the proper governance structures are put in place, managers will not act in a way as to maximize the shareholders’ interests especially in large corporations (Bowie, 1992). The relationship between the chairman and the C.E.O is vital in the establishment of such structures. The shareholders’ interests can only be safeguarded if the interests of the chief executive officer aligns with those of the shareholders which is achieved by compensating him handsomely or if the chairman of the board of directors is not under the influence of the C.E.O. Other views however, suggest that a correctly established organization structure which allows the C.E.O to perform his duties effectively, is more vital to ensuring shareholder interests are safeguarded. Through adopting the agency theory, the shareholders are the principals while the managers are the agents. The separation of control and ownership in many modern corporations has resulted in conflict of interests between the interests of the owners of the company (principal) and the personal interests of the managers appointed (Pitt 2011). Some of the decisions of the managers that result in conflict with the shareholders are highlighted below:- a. Managers at times use confidential information at their disposal to participate in insider dealings to reap gains from stock market dealings. b. Managers may spend huge sums of company monies in long holidays. c. Managers at times organize mergers that are only intended for their own personal benefit rather than for the benefit of the shareholders. d. Managers may embezzle corporate funds for their own use. e. They also award themselves hefty pay rises. There are however resolutions that can be passed to resolve the conflict. One of the methods is by remunerating managers based on their performance and actions geared towards wealth maximization of the shareholders. The remuneration scheme should be developed in a way that, enforces the harmonization of the interests of both shareholders management. It may involve giving the managers/C.E.O commissions and bonuses in case they provide superior performances in certain periods. The principal can also incur agency costs in order to monitor the activities of management such as restructuring costs which are incurred in altering the structure of the company to prevent undesirable activities by management. Other costs involved include, monitoring and opportunity costs. Giving managers the option of stock schemes is another tactic used to restrict the agency problem. Managers are entitled to buy specified number of shares from the companies they manage, at lower prices below the market price over a certain period (Sloof 2007). Managers are incentivized to perform well for the benefit of the shareholders since they also fall under the category of shareholders. The use of threat of a corporate takeover may be applied also when the management under performs resulting in the undervaluation of the shares of the company. This tactic ensures that managers perform well since if they fail to do, they risk being replaced. The agency problem is experienced in other sectors of the company like between shareholders and creditors, shareholders and auditors and shareholders and the government. The role of board of directors The board of directors has very specific roles within the corporate governance setting, but it is essentially the board’s role to hire the chief executive officer of the corporation and be responsible in the assessment of the general direction by which the business is being run and the strategy the organization adopts to implement its objectives. The board of directors’ responsibility is to select members to be included in the board’s offices. The major office is the chairman’s seat followed by the vice-chairman who takes over the responsibilities of the chairman in his absence. The other seats are secretary and treasurer. The treasurer and the secretary have very specific roles and members elect to serve in these capacities can be selected from the board or from outside the board. The selection process focusses on persons who are most qualified and those willing to work. Each board of directors has differentiating ways of handling their duties and roles (Fiduciary Duties of Directors of Charitable Organizations, 1993). However, their general roles are highlighted below. The board of directors is responsible for the recruition, evaluation, supervision, retention and compensation of the manager. Some have cited the board’s role of recruiting and monitoring the CEO as perhaps its most important role. Business boards that add value need to pursue the best possible candidate aggressively with emphasis placed on their level of education, work experience and their capability to manage corporations. By actively pursuing and searching for a candidate, the board is able to identify candidates that are highly qualified. The board should compensate the managers well and establish governance structures that are suitable for enabling smooth running of the business by the chief executive officer especially in value added businesses. The board is also tasked with establishing a governance system based on policy. There are articles of governance that stipulate the framework for their establishment but it is the board’s role to develop the policies. It entails defining rules and regulations of the organization that members of it must adhere to and how the business is going to be run. By doing so, the board provides policies that guide its actions and those of the manager(s).However, the roles should be flexible and broad to allow for analysis and amendment if need be and for giving room for the achievement of the goals of the business. They are tasked with providing the organization with direction. It is imperative that the board adopts a mission, vision and goal for the organization. This role is however a partial role since the responsibility is shared between the board and the general manager or C.E.O of the business. The board has a fiduciary duty to the organization. It is the board’s duty to safeguard the investments and assets of the shareholders or members of the organization. The duty extends to protecting the interests of the shareholder in the company by making sure that the company’s assets (plant, machinery, equipment and the employees) are kept in good condition (Brown 1976). It is also the board’s responsibility to govern the organization and act as a check on the C.E.O. This is achieved by developing a governance system and through the system, interactions between the board and the C.E.O are laid out with the purpose of ensuring the C.E.O performs his duties as stipulated and intended. A monthly board meeting is usually where they interact formally but in the interim, they board is appraised on business matters by the C.E.O through phone conversations or any appropriate means of communication. It is the board’s duty to control and monitor function. The board is tasked with hiring an auditor who audits the financial statements and books of accounts to ascertain the financial position of the organization. By hiring auditors in timely fashion, the board is able to safeguard the interests of the shareholders. The board also ensures organizational planning, determines and monitors the organization’s products and services and serves as a court of appeal. The role of the C.E.O The C.E.O is tasked with leading the execution and development of a company’s long term business strategy by improving the shareholder’s value through wealth creation. The C.E.O is solely responsible for the management of the day to day running of the business and implementing both short and long term goals of the company. The specific roles are highlighted below. The C.E.O is mandated to develop a company’s strategy in corporation with the board of directors. Together, they are tasked with providing direction for the company. This is achieved by developing plans (short and long term) which are implemented by the C.E.O in accordance with the strategy laid out (Wright 2011). It is the C.E.O’s duty to staff and organize the company appropriately. The C.E.O has the authority to hire and fire staff that he deems under par or those that do not enhance the achievement of the development strategy laid out for implementation. Ensures that expenditures pertaining to the company are within the set limits as authorized by the company’s annual budget. This is accomplished by assessing the primary risks of the company in order to make sure that risk are properly managed and monitored. It is the C.E.O’s duty to ensure that effective internal control measures are in place coupled with management information systems. By doing so, the company is able to abide by the ethical codes of conduct set by the Company’s Act and be legally appropriate. It is also the C.E.O’s responsibility to ensure that the company maintains the required high standards of social responsibility and corporate citizenship in each place that the company conducts business activities (Larcker 2011). The C.E.O acts as a link between the management and board of directors. He communicates on behalf of the other managers and relays their issues to the board for approval and implementation if it is granted. Through liaison with the board, the C.E.O communicates efficiently with shareholders, government, employees, the public and other relevant stakeholders. The C.E.O is tasked with keeping abreast in matters relating to the financial activities of the company and all external material factors that affect the company. This is achieved by ensuring that adequate systems are in place to facilitate the company’s easy flow of information (Buxton 1998). Other responsibilities are requesting special meetings with the board when appropriate, determining the date, time and location of the A.G.M to shareholders, sitting on committees of the board. The C.E.O ensures that the company abides by specific internal control systems and encourages employees to conduct their activities by following the laws and the company’s policies and standards including its health, safety and environmental policies (Corporate Social Responsibility: Future Directions, 1981). The role of the chairman of the board The primary goal of the chairman is ensuring that the board is adequate ad efficient in developing and implementing the company’s direction and strategy. A chairman is appointed by the board on either a part time or full time basis and his role is sometimes combined with the role of a C.E.O presiding over a small company. Public companies listed in the Stock Exchange do not advice for the combination of the roles. The main roles of the chairperson are outlines below (Lechem 2002). The chairman is expected to be the company’s foremost representative in matters relating to the representation of the company’s policies and aims to the general public. The chairman as his title suggests, takes chair of board meetings. He is involved in determining the order of the agenda of the meeting, keeping track of the contributions of directors, facilitating the board to get information that is accurate and on time. He also ensures that directors contribute their opinions and are involved in the decision making process during the meetings. The manager should guide the meetings in direction that demands the emergence of a consensus opinion in order that the meeting is summed up and all members privy to the meeting emerge from it having agreed and understood the resolutions passed (Brodsky 1984). It is the chairman’s duty to take responsibility in overseeing the inclusion and development of directors and by supporting the chief executive officer. It is the chairman’s role to determine the structure and composition of the board. Constant reviews of the board regarding its size and structure, the balance between the executive and non-executive members is important. The balance should place emphasis on the directors’ age, personality and experience (Seitzinger 1987). Other roles include ensuring the board is focused in its duties achieved through planning and running the board meetings effectively and by making sure that the directors participate in board work. The chairman also ensures that there is effective communication with the shareholders by ensuring the proper information is availed to the board at all times. References Kulkarni, Mukhund S. Agency Theory. Hull: Barmarick Publications, 1988. Print. Pitt, Kate. The Assumption of Agency Theory. London: Routledge, 2011. Print. Bowie, Norman E. Ethics and Agency Theory: An Introduction. New York: Oxford UP, 1992. Print. Sloof, Randolph, and Mirjam Van Praag. Performance Measurement, Expectancy and Agency Theory an Experimental Study. Bonn, Germany: IZA, 2007. Print. Wright, Patrick M. The Chief HR Officer Defining the New Role of Human Resource Leaders. San Francisco, Calif.: Jossey-Bass, 2011. Print. Brown, Courtney C. Putting the Corporate Board to Work. New York: Macmillan, 1976. Print. Corporate Social Responsibility: Future Directions : 1981 Chief Executive Officer Conference : Report on Proceedings, Oak Brook, Illinois, September 27-28, 1981. Washington, D.C.: Center for Corporate Public Involvement, 1981. Print. Ruxton, Kathy B. Executive Pay 1997: Chief Executive Officer Compensation at S & P Super 1,500 Companies as Reported in 1997. Washington, DC: Investor Responsibility Research Center, 1998. Print. Fiduciary Duties of Directors of Charitable Organizations. St. Paul, MN: [Minnesota Attorney Generals Office, Charities Division], 1993. Print. Lechem, Brian. Chairman of the Board a Practical Guide. Hoboken, N.J.: John Wiley & Sons, 2002. Print. Larcker, David F., and Brian Tayan. The Duties and Liabilities of the Board of Directors. Upper Saddle River, N.J.: FTPress Delivers, 2011. Print. Brodsky, Edward, and M. Patricia Adamski. Law of Corporate Officers and Directors: Rights, Duties, and Liabilities. Wilmette, Ill.: Callaghan, 1984. Print. Borbély, Adrian. "Agency in Conflict Resolution as a Manager-Lawyer Issue: Theory and Implications for Research." Negotiation and Conflict Management Research: 129-44. Print. Borbély, Adrian. "Agency in Conflict Resolution as a Manager-Lawyer Issue: Theory and Implications for Research." Negotiation and Conflict Management Research: 129-44. Print. Seitzinger, Michael V. Duties and Responsibilities of Members of a Corporations Board of Directors. Washington, D.C.: Congressional Research Service, Library of Congress, 1987. Print. Read More