Module 2: Agency Problems, Legal Strategies And

Enforcement
 
Separation of ownership and management- not only cumbersome,
issues of expertise and commitment
 
Therefore specialist cadre of corporate managers- they do not
simply do what shareholders rather they are supposed to develop
and implement a strategy
 
Very broad discretionary powers- Section 179
179. (1) The Board of Directors of a company shall be entitled to exercise all such powers, and to do
all such acts and things, as the company is authorised to exercise and do:
 
Provided that in exercising such power or doing such act or thing, the Board shall be subject to the
provisions contained in that behalf in this Act, or in the memorandum or articles, or in any regulations
not inconsistent therewith and duly made thereunder, including regulations made by the company in
general meeting:
Provided further that the Board shall not exercise any power or do any act or thing which is directed or
required, whether under this Act or by the memorandum or articles of the company or otherwise, to be
exercised or done by the company in general meeting.
 
[180. (1) The Board of Directors of a company shall exercise the following powers only with
the consent of the company by a special resolution, namely

 
Power corrupts and absolute power corrupts absolutely-Managers
will have the temptation to overvalue their claims(Agency
Problem)
 
Agency cost is about costly monitoring of the actions of agent.
The greater the discretion with the agent, the larger these agency
costs are likely to be.
 
Duties of Directors
166. (1) Subject to the provisions of this Act, a director of a company shall act in accordance with
the articles of the company.
(2) A director of a company shall act in good faith in order to promote the objects of the company for
the benefit of its members as a whole, and in the best interests of the company, its employees, the
shareholders, the community and for the protection of environment.
(3) A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment.
(4) A director of a company shall not involve in a situation in which he may have a direct or indirect
interest that conflicts, or possibly may conflict, with the interest of the company.
(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage
either to himself or to his relatives, partners, or associates and if such director is found guilty of
making any undue gain, he shall be liable to pay an amount equal to that gain to the company.

 
Agency Problem 1 arises when the welfare of one party, termed
the principal depends upon action taken by another party termed
the agent. The problem lies in motivating the agent to act in the
principal’s interest rather than simply in the agent’s own interest.
(Conflict between the firm's owners and its hired managers)
 
Agency Problem 2- Majority or controlling interest shareholders
vs. minority or non-controlling owners. Involves the conflict
between, on the one hand, owners who possess the majority or
controlling interest in the firm and, on the other hand, the
minority or noncontrolling owners.
 
Agency Problem 3- Conflict between the firm itself- shareholder
primacy vs. Stakeholder approach( Sections 166(2), 135,181, etc
 
The third agency problem involves the conflict between the firm
itself—including, particularly, its owners—and the other parties
with whom the firm contracts, such as creditors, employees, and
customers. Here the difficulty lies in assuring that the firm, as
agent, does not behave opportunistically toward these various
other principals—such as by expropriating creditors, exploiting
workers, or misleading consumers.
Legal strategies that the law employs to address these problems.
The normative goal of advancing aggregate social welfare is
generally equivalent to searching for optimal solutions to the
corporation’s agency problems, in the sense of finding solutions
that maximize the aggregate welfare of the parties involved—that
is, of both principals and agents taken together.
The ESV model(The United Kingdom Companies Act, 2006 (c.46) s.
172) prescribes board can consider their interests but only as long as
such consideration ultimately enhances the value of the shareholders
in the long run. The Pluralist Model(Section 166(2), on the other
hand, prescribes that looking after the interests of the stakeholders
should be the aim of the Board as an end in itself and not just as
means to enhance shareholder value.
Mihir Naniwadekar and Umakanth Varottil, The Stakeholder
Approach Towards Directors’ Duties Under Indian Company Law: A
Comparative Analysis (2016) (NUS Centre for Law and Business,
Working Paper Series 16/03) “While Section 166 (2) of the 2013 Act
at a superficial level extensively encompasses the interests of non-
shareholder constituencies in the context of Directors’ duties and
textually adheres to the pluralistic approach, a detailed analysis
based on interpretation of the section and the possible difficulties that
may arise in its implementation substantially restricts the rights of
stakeholders in Indian companies.”

Legal strategies for controlling agency costs can be divided into two
subsets:
(a)- Regulatory- They are prescriptive and ex-ante in nature.
Examples are: Setting the terms of entry and exit(Section 52(4)),
Section 166- Duties of directors.
(b)- Governance-based- They are facilitative in nature. The
power to remove directors- Section 169, etc.
 
RPA- Regulatory, prescriptive and ante
 
(a) Section 166 like sections,
(b) the setting of the term of entry of directors- S. 152(4)+ 164,
etc.
 
GFP- Governance, Facilitative, post
(a)-Removal of directors – Section 169
 (b)- initiation- EGM
( c) Reward strategy- Stock options- ) + Sections 62(3)(b)+ 2(37)
and Rule 12 of Companies(share capital and debenture rules)

Enforcement institutions/models
They are of first-order importance for regulatory strategies and of
second-order importance for governance strategies.
1. Public officials- Wide variety of state organs.
2. Private Parties acting in their own interest- Derivative suit-
Section 241
3. Gatekeepers- Auditors
Modes of enforcement
a. Public enforcement- Section 248, etc
b. Private enforcement- Sections 241, 245
c. Gate keeper control- Auditors- 102(2)(a) (i)+ 143(2)
 
Which strategy is apposite in the Indian context, and why? Page
4 of Article
 
Regulatory + Robust Enforcement mechanism
 
YOU BE THE JUDGE!

What do you suggest for India? A Legal framework inclined

towards Regulatory Strategy or Governance based strategy?