Agency Theory and Stakeholder Theory - Coursework Example

Compare and contrast agency theory and stakeholder theory. Which theory in your view offers the most useful insights into corporate behaviour? Name: Course: Institution: Date: Introduction and Framework In the contemporary society, matters related to corporate behaviour and governance have been considered more important in matters related to the operationalisation of different companies. This is because through governance structures, companies often determine the goods or services to provide. In addition, it is through corporate governance that the decision making process is streamlined in relation to the target market. Company board of directors, the management and employees have the responsibility of ensuring that every aspect of operations in agreement with the mission and objectives of the said company. Corporate behaviour is largely influenced by the prevailing culture within the society and an organization. This often helps in the determination of organizational values and attitudes that employees and the management of an organization adapt in relation to customer expectations. The main objective of this paper is to conduct a comparative analysis on agent theory and stakeholder theory. In addition, it will also determine the most appropriate theory in understanding maters of corporate governance and behaviour. Corporate governance Corporate governance is one of the fundamental aspects in understanding matters related to the management of public institutions. The process of defining corporate governance requires the inclusion of professional code of ethics, values, transparency, accountability and fairness (Calder 2008, p. 39). This means that the main purpose of corporate governance in an organizational setting is to ensure that the board of directors, being the representatives of company owners must always protect resources that are allocated to the company. This can be through developing a plan towards the definite mandate of an organization, corporate governance also ensures that those charged with the responsibility of management are accountable to the owners of the organization (Hirschey et al 2009, p. 35). In addition, it is also through corporate governance that the board can be held accountable by shareholders and other stakeholders. The introduction of the concept of corporate governance was a technique through which an organization could ensure that it is authentically committed to its mission and vision statements as a way of creating and sustaining high levels confidence of its investors and other stakeholders (Mallin, 2013, p. 37). This is however possible in situations where the organizations are able to craft their corporate governance structures in ways that reflect fairness and balance in the management of a company (Rezaee 2008, p. 56). This ensures that the said organizations remain responsive to dynamic market risks while acknowledging the essence of recognizing available opportunities to the wellbeing of the company. This makes it important for the management to engage in public disclosure of their corporate governance structures (Urlacher 2008, p. 78). Through such disclosure, it will be easier to gauge the strength of an organization’s corporate governance systems. In addition, the issue organizational sustainability has also become increasingly important since the stakeholders are more focussed on the figures that are reported including the techniques of reporting (Idowu & Caliyurt 2014, p. 45). There are factors such as the global financial crisis, which have increased the intensity through which corporate governance structures are held responsible for organizational management. This is because the expectations of the shareholders on matters related to transparency and fairness have raised the bar for more elaborate and proactive disclosures. When assessed from this perspective, the issue of corporate governance may be relatively complex due to the issues related to its application in different context. This explains why it will be important to engage in a process of exploring constituent elements such as the element of company and governance. The element of company is considered as one of the most innovative concepts in the modern age. This is because of the technique through which it emerged from a mixture of partnerships, elements of trust and contact law. Since the establishment of the concept of the company using the legal providence such as the Limited liability Act of 1885 coupled with the Joint Stock Companies Act of 1856, the modern company has been able to distinguish between ownership and control, responsibility and liability, debt and equity (Boubaker & Nguyen 2014, p. 46). This has enabled different organizations in the business sector to engage in effective management and efficient financial operations. Private businesses across the world have also embraced this approach to business hence making the concept of corporate governance an indispensable aspect in the management of organizations (Cornelius 2003, p. 78). There have been attempts to institute regulation and control measures in the operations of companies as in the case of the South Sea Bubble. The Blue Sea Company was involved in the corrupt practices that led to the manipulation of its share process. This action led to the introduction of the Bubble ACT in 1719, which prohibited the sale of shares by companies operating without a charter (Cornelius 2003, p. 80). This Act was perceived to be detrimental to the private sectors since it was a public regulation measure that prevented the private sector from conducting business as corporate bodies. The Act that was introduced in the 18th century provided a platform of deliberation on matters related to corporate governance, especially on how the private sectors would balance issues of control and freedom (Cornelius & Kogut 2003, p. 88). The issue of balancing freedom and controlling the private sector has been a recurrent theme since the 18th century. This is because during the periods of crisis and reform the balancing point in the context of the private sectors has often been readjusted to meet the demands of the prevailing market economies. Clarke (2004, p. 165) provides a demonstration of how matters related to the interests and acts of corporate governance often happen in times of economic downturns. In addition, these demonstrations also encompass the contributory role of the reforms in the failure and reassessments of the efficiency of systems regulation (Donaldson & Davis 1991, 52). It is important to note that the situation has however been different in situations where countries have been faced with economic growth (Cornelius & Kogurt 2003, p. 88). With these assumptions in mind, it would be necessary to engage in the analysis of the theories of corporate behaviour, stakeholder theory and agency theory. This analysis will be aimed at comparing the theories in terms of how they contribute to the ability of private business entities to balance control and freedom. Agency theory and stakeholder theory Agency theory Agency theory is an economic approach to the understanding of corporate governance and behaviour. This approach is largely concerned with incentives that the managements receive as agent of the stakeholders. The research paper will be engaged in an exploration of the defining attributes of agency theory: the cost of conducting transactions in business, the agency cost between the agent and the principles and the complications involved in intra-principle conflicts. To be able to realize this objective the paper will use the case of Enron Company. This is a contemporary institution, which will provide the most appropriate insight into the extent to which Agency theory can be used in understanding the concept of corporate behaviour and its essence in corporate governance. Agency theory hold the assumption that the transaction cost is a major reason why companies exists in the market. From this, approach it would be important to develop the understanding that companies are basically a series of contracts whose making is often aimed at improving the wellbeing of the firms in terms of market share and its competitive advantage (Chetty & Saez 2007, p. 46). It is the responsibility of the management to act on behalf of the shareholders while making decisions on how the company is to operate in the competitive market. According to Coarse (1937, p. 386) when the cost of engaging in market activities and enforcing contracts are relatively higher compared to the cost of engaging authority in the allocation of essential resources, them it would be necessary to integrate economic activities within the confines of the company. This means that for a company to grow in terms of its ability to engage in different market transactions, it must have the ability to determine the cost of certain transactions in the market and the ability of the company to integrate such transactions within the confines of its management (Evans 2000, p. 34). Since its foundation in 1985, Enron Company was engaged in different mergers with other companies such as Huston Natural Gas and Internorth. These merges made Enron a major player in the industry to the extent that it was ranked position seven among the fortune 500 companies (Fernando 2009, p. 77). Under the leadership of its chairman, the company became a major energy and petroleum products trader on the international market. Through an elaborate understanding of the role of the management in improving the position of the company on the market, Enron moved its operations to the online platform as a major market maker in natural gas, petroleum products and electricity (Niskanen 2007, p. 56). Through the diversification of its markets into additional areas such as shipping, the coal industry and the steel industries, the company became a major employer in different countries (Niskanen 2007, p. 57). In addition, by 2002, the company was reporting revenues in the tune of $80 billion while its profits were at $1billion (Fernando 2009, p. 79). The different levels of progress helped the company acquire the recognition of one the most innovative and fastest growing companies in the world. This brings with it the understanding that Enron Company prior to its collapse was a giant player in the market with contracts and thousands of contractors, thousands of employees and customers (Fernando 2009, p. 100). In addition, transaction cost in the understanding of the agency theory lead to the existence of fortune 500 companies such as Enron in terms of size and scale. This is because without the truncation costs these companies would face inadequacies and inefficiencies in their operations (Fernando 2009, p. 103). Agency cost also plays a significant role in understanding the role of agency theory in boosting corporate governance and behaviour. According to Jensen and Meckling (1976), the relationship between the principle and the agent makes it relatively impossible to assert that the agent will make optimal decisions art zeros cost. This according to the principle is relatively difficult hence, the need to consider different aspects of agency cost (Jensen & Meckling 1976, p. 5). The principal played the oversight role by engaging in monitoring and evaluation of the decisions that agents make on his behalf. These decisions will often require some form of expenditure hence the agency cost. Agency costs involves the intentions by the principal to regulate the behaviour of the agent by paying the agent a specific amount of financial resources as a way of ensuring that the agent does not engage in any form of malpractice of take actions that would harm the principal (Chetty & Sae 2007, p. 100). These types of harm are those that would deny the principal the opportunity of driving benefits or profits from the actions of the agent. Agency cost presents the notion that it is important for the principle to provide the agent with specific amounts of resources that would act as motivation and ensure that the agent operates and makes decisions intended to boost the economic welling of the agent (Armstrong 2002, p. 56). This means that there has to be some variance between the decisions taken by the absent and those decisions that could maximize benefits to the principal. The agency cost is therefore the cost incurred in running a company. These costs are considered to be as beneficial to the welling of the company. The shareholders are the principals in this context making the management their agents. The management has the responsibility of operating with the resources provided to make decisions that would ensure that the company achieves its targets in terms of market share and profits margins (Chetty & Saez 2007, p. 123). The agency cost involved in the operationalization of Enron Company prior to its collapse had become relatively significant. This was because the company was operating on multinational level and to boost its presence in the market it was important to invest $900 million in employee pension annually (Rapoport 2004, p. 23). This was meant to act as a motivator for their efforts in building the company. Agency costs are therefore important determinant of how organizations are governed that the resulting behaviour in term of the ability of employees to engage in developmental initiatives (Weiss 2014, p. 78). A problem within an agency often arises when there is some form of complication in engaging in a perfect contracting system where all the actions of an agent affect his welfare and that of the principal. The major problem in such situation encompasses the techniques through which the agent can ensure that his actions are in the best interest of the principal. According to the agency theory, the management bears the utmost cost whenever there is any form of failure in addressing the objectives of the principal. According to Jensen and Meckling (1776, p. 89) the reduction of the incentives provided to the management comprises the reasons for their failure to realize the objectives of the principal and those of the organization. In case of any additional costs, agency problems can only be captured by financial markets and reflected in the financial markets in terms of the company’s share price. Agency cost from this perspective is therefore some value loss to the principal. This is because it arises from the differences in terms of the interest between the principal and the management. For the principal to ensure that the strategies as developed by the management are envisioned to promote the wellbeing of the company and an improvement of share dividends, it will be important to define agency cost in terms of bonding cost, residual loss and monitoring cost (Jensen and Meckling 1976, p. 67). Intra-principal conflict has also been perceived as major contributor to the problem arising from agency theory. These forms of conflicts are of major concern to the understanding of this theory due to their prevalence the contemporary society (Finkelstein et al 2009, p. 47). The major problem arises from the intentions by the majority shareholders to restrict the movements and operations of majority shareholders instead of restricting the rate of wealth creation and empire building by the management, which is largely unaccountable to shareholders (Finkelstein et al 2009, p. 55). At Enron Company, the major shareholders had contributed to its collapses due to their decision to provide residual control rights to the management. With high levels of discretion, that the residual rights accorded to the management it was possible for financial resources to be misallocated. The separation of ownership and management enabled the firm’s executive officials to expropriate the company money for their own initiatives (Rapoport 2004, p. 56). This is an indication that the primary focus of the agency theory id the economic aspects of governance that will determine the behaviour of the management and employees when incentives are provided (Freeman 2010, p. 67). However, in stakeholder theory focuses on all the other players that have a role in the existence of a firm. This is therefore a pluralistic approach towards the realization of organizational goals. Stakeholder theory The stakeholder theory holds the assumption that the main purpose of corporate management is to act in the best interest of its shareholders who include the employees, the customers, the society, the shareholders and the suppliers. One of the differences between the stakeholder theory and the agency theory is that the latter focuses on the relationship between the principal and the agent at the expense of the other players (Donaldson & Preston 1995, p. 67). According to the stakeholder theory, it is the responsibility of the management to protect the wellbeing of the corporation. This approach to safeguarding the interests of the firm emerges from the understanding that the management mist always find a way of balancing the conflicting interests of its stakeholders in a way that will ensure mutual benefits for all of them (Freeman 2010, p. 70). This is based on the realization that the shareholders may want higher returns on their investments, customers may want the company to spend more on research and development and the employees may demand higher pay. Through the stakeholder approach, the work of the management is not to give preference to any of the demands but deliberate upon the best strategy that can be employed in ensuring the satisfaction of all the stakeholders (Zakhem, et al 2008, p. 192). It is important to note that not every demand can be satisfied at the same time and it would be important for the management to device ways of fining a compromise and develop some form of agreement. This is often aimed at maintaining a balanced relationship among stakeholders because any form of imbalance may jeopardize the existence of the company (Friedman & Miles 2006, p. 78). The collapse of Enron Company can be attributed to failure by the management to strike the best balance between the demands of different stakeholders. This is because by engaging in numerous partnerships and transactions such as the LMJ transaction of 1999 and the Chewco/JEDI transaction in 1997, the company was focusing on the realization of its aggressive expectations at the expense of the shareholder the inters of its shareholders (Rapoport 2004, p. 44). This explains why in 2001the company had transferred significant costs to its shareholders. This was to be blamed on the failure by the management to involve majority and minority shareholders in the decision making process concerning the sophisticated techniques through which the company was to realize an improvements in its financial results (Fox 2002, p. 58). These led to the failure by the company to pay its debts and eventual devaluation of the company. The incentives that the shareholders were to receive from the transactions do not serve the purpose of stakeholder theory. The theory assets that a consultative approach and balancing of the interest of different stakeholders prior to an intervention can serve to protect the interests of all the parties involved (Fernando 2009, p. 46). According to the stakeholder theory, it is important to redefine the purpose of a firm. This is because of the plethora of responsibilities that firms in the contemporary society have towards different sectors (Sharma & Starik, p. 23). According to this approach, the main role of a company is to maximize on the interests of the stakeholders with the understanding that such level of concern would redefine corporate governance and the actions that the management must undertake to ensure that corporate behaviour is in agreements with the objectives of the company. The stakeholder theory provides a description of reality since it reveals plurality of interests that are present in every company and provides an insight on the competitive and co-operative levels of these interests. (Donaldson & Preston, 1995, p. 66). The decision making process in contemporary corporations are defined by the goals, expectations and the available alternatives rather than the incentives that the company or its management might receive by maximizing on the existing financial opportunities (Phillips 2003, p. 69). In Enron’s case, the essence of the stakeholder theory is evident. Whereas the agency theory focuses on the relationship between the agent and the principal as critical in corporate governance, stakeholder theory recognizes the role that every stakeholders plays in the business and the impact of any decision on their wellbeing (Fernando 2009, p. 44). Enron was a company that thrived in the energy sector. The activities that defined operations in the company affected different stakeholders in varying proportions (Fox 2002, p. 60). The decision by the company executives to engage in malpractice and the eventual downfall of the company lead to loses in terms of investments on the shareholders, loss or employment among employees, loss of a source of revenue for the society and loss of a source of energy product for the customers (Fernando 2009, p. 56). Inasmuch as the management may have gained by misappropriating finances and assets, their gains were limited compared to the amount of damage caused on other stakeholders (Mahoney 2007, p. 7). The stakeholder theory when understood from this approach provides the understanding that it is a technique through which companies are able to develop a collaborative stakeholder association as an essential part of its business strategy (Sundaram & Inkpen 2005, p. 371). Through this collaborative approach, it will be easier for the management to develop the ability to balance the interest of all its stakeholders throughout the lifetime of the company (Donaldson & Preston, 1995, p. 77). This has been considered as one of the attributes of successful governance considering that a mutual relationship between all stakeholders often propels an organization into the realization of its objectives. For the stakeholder approach to be successful in the realization of the interest of any company, it will be important for that company to develop organizational values that are strong enough to ensure a clear communication of business goals as a technique of maintaining stakeholder interests (Phillips 2003, p. 89). Which theory in your view offers the most useful insights into corporate behavior? Piercing the Corporate Veil: An Insight into Corporate Behavior Both agency and stakeholder theories play an essential role in providing a platform of the evaluation and understanding of corporate governance. This also facilitates the understanding of factors necessitating different aspect of corporate behavior in an organizational setting. In terms of which theory is better than the other in explaining corporate governance and behaviour, it is would be necessary to argue that two theories complement each other. This is because through these theories it is easier to understand the individual and collective aspects that define organizational behaviour and corporate governance. Whereas the agency theory focuses on the role of utility and incentives in defining corporate governance and behavior, the stakeholder theory focuses on power and responsibility. Together the two theories provide a general outlook of organizational performance. However, when addressed independently the two theories fail in the provision of a complete understanding of corporate behavior. The agency theory in summary of the economic approach to corporate governance and behavior since it focuses on incentives, utility cost and the individual. This provides a perfect platform of understanding the problems that affect companies when ownership is distinguished from control. The agency cost in the management of major organizations since they subject the management to more stringent measures of accountability and transparency. The conflicts arising from the principal and the agent have been used in understanding the nature of companies and the techniques of improving on the level of corporate governance. For instance, at Enron conflict between the management and company owners arose from the inconsistencies in their interests and the need to improve the wellbeing of the company. This drove the management into risky endeavors hence the collapse of the company The inability of the agency theory to explain the role of sociological factors in understanding corporate governance and behavior introduced the essence of the stakeholder theory. The social factors include the need to integrate the interests of different factions of stakeholders. This is because the theory focuses on the collective role of different groups in ensuring the success of the organization. These groups are the stakeholders whose interest is to be refined and redirected by the management to ensure the extinct of some form of balance and compromise. The issue of corporate governance and behavior surpasses the incentives that different stakeholders are to receive. Instead, it focuses on other attributes such as ethical responsibilities of the organizations and its stakeholders as a way of ensuring a mutual relationship. Conclusion Companies play an important role in the development of the society. This is because of their ability to provide essential goods and services. The structures available for corporate governance and behavior often determine the purpose and success of companies in realizing its objectives. Agency theory and stakeholder theory play an essential role in determining aspects concerning corporate behavior that have effects on corporate governance. The ability of the agency theory to provide insight on the individual, utility cost and incentives, it provides information on how companies should be governed. Stakeholder theory provides a collective approach to the understanding the essence of power and status in corporate governance. These theories provide an insight and how companies act and how they should be governed to ensure an understanding of the prevailing social and economic conditions. References Armstrong, Michael. 2002. Employee reward. London: Chartered Inst. of Personnel and Development. Boubaker, Sabri, and Duc Khuong Nguyen. 2014. Corporate governance in emerging markets: theories, practices and cases. Calder, Alan. 2008. Corporate governance: a practical guide to the legal frameworks and international codes of practice. London: Kogan Page. Chetty, Raj, and Emmanuel Saez. 2007. An agency theory of dividend taxation. Cambridge, Mass: National Bureau of Economic Research. Clarke, T. 2004. 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