Assignment

Board of directors can never be the panacea to the agency conflict between managers and
shareholders of a company. Discuss

SOLUTION

As theorized by the agency theory, the private interest of the manager would be to take

advantage of future situations with the company putting him/her in concrete situations of

potential and actual Conflict of interest. However, it is the specific situation that puts the

manager in a potential, actual or apparent Conflict of interest. Therefore, the CEO or manager of

a company is seen by the agency theory as a person who will try to put himself/herself in

situations that can allow the extraction of private benefits. In that sense according to the agency

theory the CEO is in potential Conflict of interest. To solve this potential Conflict of interest

agency theory suggests implementing corporate governance mechanisms including both internal

board of directors (Denis and McConnell, 2003; Gillan, 2006).

According to agency theory the main role of the board of directors is to recognize

and monitor the conflict of interest between managers and shareholders or between the majority

shareholder and minority shareholders. This monitoring role requires that board members are
able to identify conflict of interest situations. Indeed, the board of directors is considered as one

of the internal governance mechanisms together with concentrated ownership and executive

compensation packages (Demsetz and Lehn, 1985; Fama and Jensen, 1983).

This monitoring role requires that directors are able to recognise Conflict of interest situations,

even their own Conflict of interest. In this the code of ethics and code of conduct are regarded

guides for directors (Felo, 2001), since these codes often contain conflict of interest policy of the

firm.

However, overriding conflict of interest on the part of Board of Directors is the greatest factor

causing their inability to be the panacea to the agency conflict between managers and

shareholders of a company.

Conflict of Interest on the part of the Board of Directors means, a situation in which a Board

Member or his or her Immediate Family Member has, directly him- or herself or indirectly

through another individual or entity, a personal or financial interest that compromises or could

compromise the Board Member’s independence of judgment in exercising his/her responsibilities

on behalf of the shareholders. This conflict-of-interest manifest in several ways as follows.

A conflict of interest of Board of Directors can be centered on either actual or potential conflict

between a board member and the company. The concept put directors in a position of taking

advantage of their position. As the key decision makers within the organization, board members

refusing to act in the interest of the key stakeholders, whether owners or society at large, but
rather in their own. Major conflicts of interest from this angle could include, but are not

restricted to, salaries and perks, misappropriation of company assets, self-dealing, appropriating

corporate opportunities, insider trading, and neglecting board work. All board members are

expected to act ethically at all times, notify promptly of any material facts or potential conflicts

of interest and take appropriate corrective action, this is the surest way of serving as panaceas of

conflicts of interest between management and shareholders.

Again, conflicts arise when a board member’s duty of loyalty to shareholders/stakeholders or the

company is compromised. This happens when certain board members exercise influence over the

others through compensation, favors, a relationship, or psychological manipulation. Even though

some directors describe themselves as “independent of management, company, or major

shareholders,” they may find themselves faced with a conflict of interest if they are forced into

agreeing with a dominant board member. Under particular circumstances, some independent

directors form a distinct stakeholder group and only demonstrate loyalty to the members of that

group. They tend to represent their own interest rather than the interests of the

shareholders/companies.

Also, conflict emerges when the interests of stakeholder groups are not appropriately balanced or

harmonized. Shareholders appoint board members, usually outstanding individuals, based on

their knowledge and skills and their ability to make good decisions. Once a board has been

formed, its members have to face conflicts of interest between stakeholders and the company,

between different stakeholder groups, and within the same stakeholder group. When a board’s

core duty is to care for a particular set of stakeholders, such as shareholders, all rational and

high-level decisions are geared to favor that particular group, although the concerns of other
stakeholders may still be recognized. Board members have to address any conflicts responsibly

and balance the interests of all individuals involved in a contemplative, proactive manner.

Furthermore, conflicts are those between a company and society and arise when a company acts

in its own interests at the expense of society. The doctrine of maximizing profitability may be

used as justification for deceiving customers, polluting the environment, evading taxes,

squeezing suppliers, and treating employees as commodities. Companies that operate in this way

are not contributors to society. Instead, they are viewed as value extractors. Conscientious

directors are able to distinguish good from bad and are more likely to act as stewards for

safeguarding long-term, responsible value creation for the common good of humanity. When a

company’s purpose is in conflict with the interests of society, board members need to take an

ethical stand, exercise care, and make sensible decisions.

In an attempt to increase firm performance, agency conflicts have to be reduced, different

solutions are proposed to reduce such conflicts of which one is monitoring. Monitoring on behalf

of shareholders could be internal or external. It is done internally by the board of directors who

possess adequate expertise to confirm if a decision is value maximizing or not. Also, some

executives on the board are termed ‘busy’ because they serve on multiple boards has been

reported to affect firm’s value. An external form of monitoring is done by large shareholders

who have quite a substantial amount of the firm than the average shareholder and could benefit

(loose) more if the firm’s value is appreciating (depreciating).

Some other studies believe that the presence of directors on multiple boards leads to more

agency conflicts and adversely affects firm performance knowing they are too busy to effectively

monitor the business of several firms. Perry and Peyer (2005) looked at the announcement effect

and reports that accepting the appointment of being a director depends on the agency problems
that currently exists, if agency problem is critical then a busy director negatively affects

performance but if fewer agency problems exists then appointing a busy director enhances firm

performance . Fich and Shivdasani (2006) use panel data regression and observed directors that

function in at least three boards are associated with weaker corporate governance lower market-

to-book and profitability. They also found that busy directors are less likely to be chosen again

following poor performance of the firm

A study conducted by Di Carlo (2013) on the knowledge of Conflict of interest by the Italian

civil servants showed that despite the presence of a code of ethics, where asked to deal with the

Conflict of interest, the way in which they identify the Conflict of interest is not homogeneous.

These differences could be caused by the following factors: 1) respondents do not know the

contents of the codes of ethics so they use their own knowledge to identify the phenomenon; 2)

even knowing the contents they appear inadequate for conflict of interest identification.

Management of the conflict involves the adoption of a number of approaches, carefully designed

to take into account all the contributing factors. The undertaking to act in an objective manner,

that is to act impartially and with intellectual honesty, is crucial in the management of conflicts

of interest (Boatright, 2006). Avoiding a conflict of interest by remaining vigilant to the

possibility for its occurrence is likewise a major means to management of conflict of interest.

However, whilst theoretically simple, it is often difficult to identify and anticipate conflicts. For

example, an organisation charged with managing the interests of several clients, whose interest

and activities intersect with one another, may not be in a position to identify or anticipate when

new conflicts of interest have, or may, arise (Boatright, 2006). In some cases, such as in certain

business environments where competing interests are unavoidable, conflicts of interest can be

managed by introducing measures that ensure the interests of involved parties are served. An
example of this, from a business context, is found in the process of alignment, in which the

interests of a broker are aligned with those of his or her clients through the introduction of pay-

for-performance measures (Boatright, 2006). This method encourages transparency in

practice, which is similar to disclosure, another important means for managing conflict of

interest.

The selection of individual board directors has the potential to act as a significant influence. The

skills, attributes and values of the directors are the very reasons that the directors are attractive to

the organisation. Consequently, the selection of board directors to sport organisations has the

greatest impact on the governance and management of the sport organisation and, therefore, on

the management of conflict of interest. As each director brings with them their skills and

attributes, so too do they bring networks and relationships, some of which may give rise to

potential conflict of interest. This link between director selection and conflict of interest is best

illustrated by the following extract from an interview with an AFL commissioner, ‘‘. . . if you

want to attract people to become board members, you’re going to have to accept that some of

them will come with conflicts.

Potential directors can be recruited from a variety of sources, including: ‘‘existing board

contacts, staff suggestions, funding body suggestions, friends of the organisation, key clients,

board members of other organisations, relevant professional societies, business associations and

sponsors or donors’’ (Fishel, 2003, p. 27). Director selection must acknowledge the

inherent tension between attracting directors with skills, attributes and networks, whilst avoiding

potential for conflict of interest. For many organisations, the balancing act of managing a
potential conflict of interest is ‘‘probably outweighed by the knowledge of trends and

transactions that high-level corporate officers can bring to a board’’ (Minow & Monks, 1996,

p. 188).

The selection process undertaken by organisations to appoint individual board directors has a

clear influence on the director, and this influence has the potential to impact on the management

of conflict of interest. It appears that this impact can manifest differently in the sport organisation

context, particularly for those clubs that have directors elected from their membership, by their

membership. In clubs such as these, it is not unusual to find a pastplayer, or ‘legend’ of the club

elected to the board. Notwithstanding that many past players may be well credentialed to hold

the role of director, it is argued that, in some instances, these directors are elected by popular

vote, rather than for the skills and attributes required to serve in this governance role. This,

indeed, would impact on the management of conflict of interest, as directors require a level of

understanding of the role and responsibilities of governance, largely learnt through professional

corporate experience or education.

Conversely, those directors elected or appointed to the board who hold this experience, and

thoroughly understand their governance responsibilities, are expected to be more capable of

appropriately managing conflict of interest within their sport organisation.

One of the more subtle influences on a director is their own personal motivations for holding the

position. Although the role itself may be voluntary at times, the responsibilities outlined above

require a significant investment of time, and require professional divestment of their fiduciary

obligations. As financial compensation is not a motivation for these positions, the motivations
for involvement become more emotional. This may have an influence on their role in the

governance of the organisation and subsequently an impact on the management of conflict of

interest. It also becomes an issue when directors are there for ego, control, access to business,

other business not so much their skills or their passions, it’s very much their reasons for doing it.

Caldwell and Andereck (1994) divide volunteers’ motivations into three categories: purposive,

undertaking a useful pursuit to help society; solidarity, an opportunity to network, participate in

social interaction and identify with a group; and material incentives, the garnering of tangible

rewards. This is echoed by Shilbury et al. (2006), p. 71), who asserted that volunteers who take

on such roles and engage in leisure, which involves training, gain personal feelings of

accomplishment and importance as well as social interaction and an increased identification with

the particular sport itself. It becomes clear that if the director’s motivations for involvement are

in their own self-interest be that a financial motivation, such as improving business relationships,

or for a more emotional motivation, such as personal

Previously, under the Companies Act of 1973, directors declared their interests on an annual

basis. Under section 75(4) of the current Act it would appear that directors may, in advance,

disclose their personal financial interests, which would then be considered to be disclosed until

such time as this was changed or withdrawn by the director. It would appear therefore that the

disclosure need only be made once; however, the director must still comply with the remaining

requirements of the Act insofar as recusing him or herself from the meeting, etc. However, it

would still be good practice to request directors to disclose their interests on a periodic basis. It is

also good practice to include disclosure of conflicts of interest as a standing item to the board
agenda. To the extent that a director or a related person acquires a personal financial interest in a

matter in which the company already has a material interest which has been approved by the

board, the director has a responsibility to disclose the nature and extent of the interest and the

material circumstances relating to the acquisition of the interest. Such an event may occur on, for

example, the director inheriting shares in a company with which the company on whose board he

or she sits having material transactions. Where a conflict arises for the first time during a board

discussion, the director should immediately consider whether the matter is material, both from

his and the company’s perspective, and request additional time to consider the matter if so

required. Where the director then assesses that a conflict does exist, he or she must declare the

interest and take the necessary steps as envisaged in the Act.

Notwithstanding the above and as part of on-going board development, it’s helpful for boards to

set aside time, annually, for discussing hypothetical situations where a conflict of interest could

occur. Members could role-play the situation and then discuss the situation as it pertains to their

organization’s conflict of interest policy and statement. The discussion should include how the

board would manage the potential conflict so that they are better equipped to handle a conflict of

interest when it actually occurs.

The keys to avoiding conflicts of interest are having statements and policies for managing them

and creating awareness for potential conflicts. Because of the negative consequences to the

organization, each board member has a responsibility to identify and address potential conflict.

An organisation’s conflict of interest policy should not be set-and-forget. There is an ongoing

need to understand what constitutes a conflict; to understand the ethical dimensions of the role
and to fully appreciate what fiduciary duties mean on a practical level. For boards, this is likely

to mean that there is some time dedicated to the issue for the board as a whole so there is a

shared understanding; that there is a regular process for updating changed circumstances; and

that each meeting asks for and records any conflicts as they relate to the day’s agenda.

Because we most often talk about conflicts of interest as a financial issue, directors will often

assess potential for conflict based on whether they will benefit financially. Directors are not

going to be personally better off as a result of a decision, but it puts them in a position where

they can’t bring a disinterested mind to bear that a company director needs to have, where

they’re only working for the well-being of the company. Of course, the law makes it really clear,

and outlines the basic duty for the director to act diligently, competently and free from any

conflict – but it helps to make it clear that the kind of conflicts a director needs to avoid are not

just ones of personal enrichment, but conflicts of duty.

Conclusion

Directors who found themselves in the following situations are likely to be compromised,

leading to their inability to serve as panaceas to conflict of interest between managers and

shareholders of companies.

• A director accepting frequent or lavish entertainment or gifts from management members or

contractor who has business dealings with the company.

• The director of a company proposing the appointment of a company manager that he or a close

family member has a beneficial interest in.

• The director of a company whose family member is proposed for a position within the

company or who is present when any aspect of that family member’s remuneration is discussed.
• Directors holding a material shareholding in a competing company or a company that is an

actual or potential material customer of or supplier to the company;

• Directors owning property adjacent to the company’s property or otherwise of value to the

company that could affect, or be affected by, the company’s activities;

• Directors having an advisory relationship (eg financial, accountancy, legal or consultancy) with

the company or having an interest in an advisory firm that provides material services to the

company;

• Directors being a trustee of the company’s pension scheme whilst being a nonexecutive

director of the company;

To this end, Directors have a fiduciary responsibility to disclose conflicts of interest and to act

with unfettered discretion. The good governance practices in this regard extend beyond what is

contained in the company’s Act and should be considered in all instances where a conflict of

interest is considered. Where directors breach their duties in the company’s Act, they stand to

attract civil and criminal sanction. Conflicts of interest have the potential to damage the company

as any board decision taken in which a director has an undisclosed personal financial interest is

void. Hence, rendering Directors ineffective in their quest of serving as panaceas to conflict of

interest between mangers and shareholders.

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