lnLroducLlon

1hls paper revlews and analyzes Lhe agency problem as appllcable Lo lncorporaLed companles An
aLLempL wlll be made Lo geL an lnslghL lnLo Lhe llLeraLure deallng wlLh Lhls lnLeresLlng sub[ecL As
apLly summed up by !asslm (1988) flnance Lheory poslLs LhaL Lhe goal of economlc organlzaLlons ls Lo
maxlmlze sLockholders wealLh ALLalnmenL of Lhls goal was noL an lssue when owners were also
managers Powever ln Lhe presenL day corporaLe ownershlp has become lncreaslngly dlffused wlLh
very few companles sLlll belng owned by Lhelr managers 1he separaLlon of ownershlp and
managemenL ralses Lhe lssue of Lhe relaLlonshlps beLween owners and managers ln such a seL up
dlrecLors and managers have a leeway Lo subsLlLuLe Lhelr own lnLeresLs ln place of Lhose of
shareholders 1hls ls posslble because of lnformaLlon asymmeLry beLween shareholders and
managers whlch Lend Lo glve managers a leverage Lo acL aL crosspurposes wlLh advancemenL of
shareholder needs Such a phenomenon commonly referred Lo as agency problem" ls prevalenL ln
modern day corporaLes 1he wrlLer wlll look aL Lhe corporaLe governance lmpllcaLlons of Lhe agency
problem as well as Lhe sLaLuLory and nonsLaLuLory remedles LhaL Lhe shareholders may resorL Lo ln
order Lo mlnlmlse Lhelr vulnerablllLy
ueflnlLlon of Lerms
Agency roblem

!ensen and Meckllng (1976) deflne Lhe agency relaLlonshlp as a conLracL under whlch one parLy (Lhe
prlnclpal) engages anoLher parLy (Lhe agenL) Lo perform some servlce on Lhelr behalf As parL of Lhls
Lhe prlnclpal wlll delegaLe some declslonmaklng auLhorlLy Lo Lhe agenL Applled Lo flnance Lheory
Lhe agency problem refers Lo Lhe confllcL of lnLeresL arlslng beLween credlLors shareholders and
managemenL because of dlfferlng goals (wwwlnvesLopedlacom 30/09/08) 1he agency problem
emanaLes from Lhe arrangemenL where Lhe lnLeresLs of Lhe agenL dlffer subsLanLlally from Lhose of
Lhe prlnclpal because of Lhe lmposslblllLy of perfecLly conLracLlng for every posslble acLlon of an
agenL whose declslons affecL boLh hls own welfare and Lhe welfare of Lhe prlnclpal (8rennan 1994)
LmanaLlng from Lhls problem ls how Lo lnduce Lhe agenL Lo acL ln Lhe besL lnLeresLs of Lhe prlnclpal

1he agency problem arlses due Lo Lhe separaLlon of ownershlp and conLrol of buslness flrms ln
Lheory Lhe shareholders belng Lhe owners of Lhe flrm conLrol lLs acLlvlLles ln pracLlce however due
Lo a dlffuse and fragmenLed seL of shareholders Lhe laLLer appolnLs a board of dlrecLors Lo dlrecL Lhe
affalrs of Lhe company 1he board would slmllarly delegaLe Lhe duLy of day Lo day runnlng of Lhe
organlsaLlon Lo managers ln Lerms of Lhls arrangemenL Lherefore managers are Lhe agenLs of Lhe
board whereas board members are also agenLs of Lhe shareholders As Lhe dlscusslon LhaL follows
wlll show an agency problem exlsLs when shareholders dlrecLors and managers have confllcLlng
ldeas on how Lhe company should be run
CorporaLe Covernance

CorporaLe governance can be deflned as Lhe sysLem by whlch corporaLlons are dlrecLed and
conLrolled ln llne wlLh sLakeholder expecLaLlons (klng ll 8eporL !uly 2001) Such Lask ls placed upon
Lhe shoulders of dlrecLors and senlor managemenL CorporaLe governance faclllLaLes Lhe aLLalnmenL
of common sense buslness ob[ecLlves llke effecLlve buslness and rlsk managemenL esLabllshlng and
malnLalnlng good relaLlons wlLh shareowners ensurlng reasonable and susLalnable reLurns
compllance wlLh appllcable laws and regulaLlons among oLhers

1he lnsLlLuLe of ulrecLors (lCu) ln SouLh Afrlca (2002) ldenLlfles seven (7) characLerlsLlcs of good
corporaLe governance LhaL musL be exhlblLed by lndlvlduals who make declslons on behalf of a
company 1hese are dlsclpllne Lransparency lndependence accounLablllLy responslblllLy falrness
and soclal responslblllLy 1he varlous characLerlsLlcs llsLed above wlll be fully explored wlLh reference
Lo how Lhey have been lncorporaLed ln Lhe Zlmbabwe's Companles AcL ln llghL of Lhe agency
problem corporaLe governance prlnclples asslsL ln lessenlng Lhe worry among lnvesLors abouL Lhe
professlonal manager" who wlelds excesslve power lrom Lhls undersLandlng lL can be argued
Lherefore LhaL corporaLe governance pracLlces baslcally seLs parameLers whlch aLLempLs Lo regulaLe
lnsLances glvlng rlse Lo agency problems
naLure of Lhe Agency roblem and CorporaLe Covernance lmpllcaLlons
naLure of Lhe Agency roblem

lnherenL ln any prlnclpalagenL relaLlonshlp ls Lhe undersLandlng LhaL Lhe agenL wlll acL for and on
behalf of Lhe prlnclpal 1he agenL assumes an obllgaLlon of loyalLy Lo Lhe prlnclpal LhaL he wlll follow
Lhe prlnclpal's lnsLrucLlons and wlll nelLher lnLenLlonally nor negllgenLly acL lmproperly ln Lhe
performance of Lhe acL An agenL cannoL Lake personal advanLage of Lhe buslness opporLunlLles Lhe
agency poslLlon uncovers A prlnclpal ln Lurn reposes LrusL and confldence ln Lhe agenL 1hese
obllgaLlons brlng forLh a flduclary relaLlonshlp of LrusL and confldence beLween prlnclpal and agenL

Powever Lhe prlnclpalagenL relaLlonshlp LhaL subslsLs beLween Lhe shareholder and Lhe dlrecLors on
one hand and beLween Lhe dlrecLors and managers on Lhe oLher ls fraughL wlLh some problems 1he
agency problem ls compounded by Lhe condlLlons of lncompleLe and asymmeLrlc lnformaLlon as
beLween Lhe prlnclpal and Lhe agenL Shareholders (as prlnclpals) expecL dlrecLors/board members
(as agenLs) Lo make declslons LhaL wlll lead Lo Lhe maxlmlzaLlon of Lhe value of Lhelr equlLy ln Lhe
same veln dlrecLors (as prlnclpals) expecLs managemenL (as agenLs) Lo pursue sLraLegles and
operaLlons LhaL conLrlbuLes Lo Lhe boLLomllne and are ln Lune wlLh Lhe board's expecLaLlons 1hls
scenarlo means LhaL Lhe shareholders who should sLand Lo beneflL from Lhe proflLablllLy of Lhe
company do noL have dlrecL conLrol over whaL managemenL (who generaLe LhaL proflLablllLy) does
1hls dllemma whlch ls a consequence of Lhe separaLlon of ownershlp and conLrol ralses worrles LhaL
Lhe managemenL Leam may pursue ob[ecLlves aLLracLlve Lo Lhem buL whlch are noL necessarlly
beneflclal Lo Lhe shareholders 1he dlsLance LhaL ls creaLed beLween Lhe shareholder and
managemenL Leam Lherefore breeds Lhe problem of a serlous lack of goalcongruence where Lhere
ls no allgnmenL of Lhe acLlons of senlor managemenL wlLh Lhe lnLeresLs of shareholders
CorporaLe Covernance lmpllcaLlons

AllevlaLlon of dlscrepancles beLween shareholder and manager lnLeresLs calls for sLrong corporaLe
governance measures lf shareholders are Lo be proLecLed from flnanclal losses resulLlng from
corporaLe and markeL flnanclal scandals
8ole of Lhe 8oard

CorporaLe governance besLows a varleLy of duLles on dlrecLors 8onazzl L lslam (2007) deflnes Lhe
funcLlon of Lhe board as a collecLlve responslblllLy Lo deLermlne Lhe company's purpose and eLhlcs"
Lo declde Lhe dlrecLlon le Lhe sLraLegy Lo plan Lo monlLor and conLrol managers and CLC and Lo
reporL and make recommendaLlons Lo shareholders 1o ensure LhaL dlrecLors dlllgenLly dlscharge
Lhese duLles personal llablllLy aLLaches Lo lndlvldual dlrecLors lf Lhe company can be shown Lo have
been Lradlng wrongfully" or lllegally carrylng ouL acLlvlLles conLrary Lo laws and regulaLlons 1hls
personal llablllLy wlll help lessen Lhe agency problem caused by dlrecLors pursulng Lhelr own personal
lnLeresLs
8oard SLrucLures

Cne mechanlsm of corporaLe governance LhaL may be used Lo ensure LhaL checks and balances are ln
place Lo mlnlmlse Lhe agency problem would be Lo appolnL lndependenL nonexecuLlve dlrecLors Lo
Lhe board of dlrecLors (Webb 2006) LxlsLence of lndependenL nonexecuLlve dlrecLors onLo Lhe
board wlll ensure LhaL managemenL ls monlLored for operaLlonal performance lor example ln Lerms
of Lhe 88Z Culdellnes on CorporaLe Covernance (2004) all banklng lnsLlLuLlons' boards should have a
mlnlmum of flve (3) dlrecLors Lhe ma[orlLy of whom should be nonexecuLlve lurLher ln Lerms of
Lhose 88Z guldellnes Lhe Chlef LxecuLlve Cfflcer (CLC) or Lhe Managlng ulrecLor (Mu) of a bank may
noL be a chalrman of Lhe board a poslLlon whlch may only be fllled by an lndependenL nonexecuLlve
dlrecLor 1hls poslLlon was also supporLed by !ensen (1993) who suggesLs LhaL ''duallLy'' reduces Lhe
monlLorlng power of Lhe board of dlrecLors 1hus a board more llkely Lo proLecL shareholders from
agency problems would be one wlLh separaLe lndlvlduals conLrolllng Lhe flrm and Lhe board (8onazzl
2007) Such a board composlLlon ls lmporLanL ln ensurlng LhaL lnLeresLs of mlnorlLy shareholders are
proLecLed and glven due conslderaLlon ln Lhe declslonmaklng process

8elaLed Lo Lhls lssue flrms whose CLCs are also parL of Lhe flrm's foundlng famlly Lend Lo have hlgher
agency cosLs and monlLorlng needs Lhan flrms wlLh unrelaLed CLCs lor example Morck eL al (2000)
flnd LhaL famlly managemenL ls lnferlor Lo professlonal managemenL 1hey show LhaL Lhese CLCs
have less conLrol over Lhe agency problem Lhan CLCs who are noL founders (or founder's helrs) of
Lhe flrm 8esearch has focused on Lhe Lheory LhaL a sLrong board of dlrecLors ls one LhaL ls able Lo
effecLlvely monlLor managemenL and allevlaLe agency problems LffecLlve dlrecLors are Lyplcally
Lhose LhaL make Lhe board more lndependenL from Lhe lnLernal worklngs and lndlvlduals of Lhe flrm

Powever Lhere are some boards whlch do noL conform Lo codes of corporaLe governance llke Lhe
Cadbury (1992) 8eporL hence are suscepLlble Lo manlpulaLlon by managemenL Lo Lhe deLrlmenL of
Lhe shareholders Core eL al (1999) examlne a wlde range of board characLerlsLlcs and flnd LhaL flrms
wlLh weaker governance sLrucLures have more agency problems and LhaL Lhese flrms Lend Lo
perform worse Lhan sLrongly governed flrms Speclflcally Lhey flnd an lnverse relaLlonshlp beLween
board sLrengLh and a number of board characLerlsLlcs Among Lhese are Lhe proporLlon of lnslde
dlrecLors board slze gray dlrecLors (Lhose dlrecLors who are noL employees of Lhe flrm buL recelve
paymenL from Lhe flrm for servlces oLher Lhan dlrecLorlal duLles) and when Lhe CLC ls also Lhe board
chalr Shlvdasanl and ?ermack (1999) flnd LhaL gray dlrecLors have a confllcL of lnLeresL and can
enhance managemenL enLrenchmenL by Lhelr presence on Lhe board All Lhese characLerlsLlcs do noL
auger well wlLh LeneLs of good corporaLe governance as Lhey reduce lndependence and Lherefore
lead Lo poorer monlLorlng by Lhe boards A board whlch ls domlnaLed by dlrecLors who are also
members of Lhe execuLlve employees of Lhe company are noL lndependenL Such a seL up would
mean LhaL managers and board members may pursue goals whlch do noL necessarlly lead Lo Lhe
maxlmlzaLlon of Lhe value of Lhe share holders equlLy As Webb (2006) observes such a board would
encourage enLrenchmenL" and managerlallsm" 8y enLrenchmenL managemenL would
be proLecLlng Lhemselves Lhrough reduclng Lhe monlLorlng power of Lhe board

Where execuLlve dlrecLors seek Lo enLrench Lhelr poslLlons ln Lhls manner Lhe board would have
dlverLed from performlng lLs sLewardshlp" role whlch advances shareholder lnLeresLs Slnce Lhe
board may noL be fully lndependenL from managemenL and Lhere ls a large gap beLween Lhe
managemenL and Lhe board Lhe managers and Lhe board may be LempLed Lo have goals LhaL
compeLe wlLh shareholder wealLh maxlmlzaLlon Slmon PerberL (quoLed ln 8ayslnger and Posklsson
1990) proclalmed LhaL managers mlghL be saLlsflers" raLher Lhan maxlmlsers" le Lhey Lend Lo acL
ln a rlskaverse manner and seek an accepLable level of growLh because Lhey are more concerned
wlLh perpeLuaLlng Lhelr own exlsLence Lhan wlLh maxlmlslng Lhe value of Lhe flrm Lo lLs shareholders
1he followlng are some of Lhe speclflc confllcL areas whlch are exacerbaLed by poor
corporaLe governance pracLlces namely
Larnlngs reLenLlon confllcLs

Managers may lncrease reLalned earnlngs ln order Lo flnance some pro[ecLs whlch would noL
necessarlly enhance shareholder wealLh Such grandlose managerlal lnvesLmenL pollcles (LasLerbrook
1984) may noL produce resulLs LhaL are clearly apparenL Lo Lhe shareholders as lL may be Lo
managemenL 1he resulLanL growLh granLs Lo managemenL a larger power base [ob securlLy greaLer
presLlge/sLaLus and an ablllLy Lo domlnaLe Lhe board and award Lhemselves hlgher levels of
remuneraLlon (!ensen 1986) Cn Lhe oLher hand shareholders would prefer hlgher levels of cash
dlsLrlbuLlons especlally where Lhe company has few lnLernal poslLlve neL resenL value (nv)
lnvesLmenL opporLunlLles hence produclng a clash of lnLeresLs beLween prlnclpal and agenL
1lme Porlzon Agency ConfllcLs

McColgan (1991) observes LhaL confllcLs of lnLeresL may also arlse beLween shareholders and
managers wlLh respecL Lo Lhe Llmlng of cash flows Shareholders wlll be concerned wlLh all fuLure
cash flows of Lhe company lnLo Lhe lndeflnlLe fuLure Powever managemenL may only be concerned
wlLh company cash flows for Lhelr Lerm of employmenL leadlng Lo a blas ln favour of shorL Lerm hlgh
accounLlng reLurns pro[ecLs aL Lhe expense of longLerm poslLlve nv pro[ecLs lor example research
and developmenL (8u) expendlLures would Lend Lo decllne as Lop execuLlves approach reLlremenL
(uechow and Sloan 1991) 1hls ls because 8u expendlLures reduce execuLlve compensaLlon ln Lhe
shorLLerm yeL Lhe reLlrlng execuLlves won'L be around Lo reap Lhe beneflLs of such lnvesLmenLs
Pealy (1983) also poslLs LhaL Llme horlzon agency confllcL may also lead Lo managemenL uslng
sub[ecLlve accounLlng pracLlces Lo manlpulaLe earnlngs prlor Lo leavlng Lhelr offlce ln an aLLempL Lo
maxlmlse performancebased bonuses
1o mlLlgaLe agalnsL negaLlve consequences of Lhe agency problem ouLllned above varlous
sLaLuLory and nonsLaLuLory mechanlsms may be employed as analysed below
SLaLuLory roLecLlon avallable Lo Shareholders 1he Companles AcL ChapLer 2403

LeglslaLlon ln Lhe form of Lhe Companles AcL (hereafLer Lo be referred Lo as Lhe AcL") has been
promulgaLed Lo afford shareholders some proLecLlon ln Lhe face of challenges caused by Lhe agency
problem Such proLecLlon ls crlLlcal glven Lhe vasL powers LhaL dlrecLors have As noLed by volpe
(1979) (clLlng 1eLL and Chadwlck Zlmbabwe Company Law) dlrecLors may acL lndlvldually or
corporaLely as a board or ln commlLLees or by appolnLlng one or more managlng dlrecLors or
managers responslble Lo Lhem As a board Lhe dlrecLors may concern Lhemselves wlLh anyLhlng
beLween Lhe exLremes of day Lo day managemenL and overall pollcy and responslblllLles
CuallflcaLlons and AppolnLmenL of ulrecLors

SecLlon 173 of Lhe AcL proscrlbes who may become a dlrecLor lor example a person wlLh any legal
dlsablllLy an unrehablllLaLed lnsolvenL and a person convlcLed of cerLaln classes of economlc crlmes
are noL ellglble for appolnLmenL as dlrecLor 1he ob[ecLlve for placlng such resLrlcLlons as noLed by
ChrlsLle (1998) ls Lo keep dlrecLorshlp and managemenL of Lhe company under responslble hands
1hls screenlng process wlll glve solace Lo Lhe shareholder who would know LhaL hls lnvesLmenLs are
under Lhe sLewardshlp
of dlrecLors who can be LrusLed

lurLher Lhe AcL requlres dlrecLors (Lhe agenLs) Lo be appolnLed by shareholders (Lhe prlnclpals)
SecLlon 174 of Lhe AcL glves members/shareholders an opporLunlLy Lo conslder merlLs of each
dlrecLor lndlvldually ln Lerms Lhereof no appolnLmenL of Lwo (2) or more dlrecLors may be made by
Lhe same resoluLlon aL a general meeLlng 1hus Lhe quallflcaLlons requlred of dlrecLors as well as Lhe
appolnLmenL procedure Lo be followed ensure LhaL lncldenLs of adverse selecLlon and moral hazard
are mlnlmlsed
8emoval of ulrecLors by Shareholders

1o ensure LhaL some checks and balances exlsL Lhe AcL has a procedure for Lhe removal of dlrecLors
by shareholders ln Lerms of secLlon 173 of Lhe AcL (read wlLh secLlon 133) shareholders can uLlllze
Lhelr power from Lhe democraLlc process of voLlng by whlch means Lhey can elecL or dlsmlss
dlrecLors When approprlaLely used Lhe power Lo remove dlrecLors from offlce would effecLlvely
afford shareholders proLecLlon agalnsL erranL dlrecLors who Lend Lo pursue pracLlces LhaL work aL
crosspurposes wlLh lnLeresLs of shareholders
llduclary uuLles of ulrecLors no ConfllcL of lnLeresL

As noLed by ChrlsLle (1998) Lhe relaLlonshlp beLween Lhe dlrecLor and Lhe company ls a unlque one
A dlrecLor sLands ln a flduclary relaLlonshlp Lo Lhe company As such a dlrecLor ls sLaLuLorlly bound
by Lhe AcL Lo dlscharge hls duLles and exerclse hls powers for Lhe beneflL of Lhe company noL hls
own 1hls should be reflecLed ln Lwo ma[or ways flrsLly LhaL dlrecLors should acL wlLh sklll and care
and secondly LhaL Lhey should acL ln good falLh 1hus Lo proLecL Lhe lnLeresLs of shareholders of Lhe
company a dlrecLor ls requlred Lo exhlblL LhaL degree of sklll whlch can reasonably be expecLed of a
person of hls knowledge and experlence and avold any confllcL of lnLeresLs 1able A" ArLlcles as read
wlLh secLlon 186 of Lhe AcL Lherefore places a speclal procedure Lo be followed where dlrecLors are
requlred Lo declare any posslble confllcLs of lnLeresLs LhaL may compromlse Lhelr ob[ecLlvlLy when
dlscharglng company buslness Such a procedure helps preclude lncldenLs of abuse by dlrecLors and
managers who sLand Lo beneflL from
lnslde lnformaLlon Lhey may have galned by vlrLue of Lhelr poslLlons ln Lhe company
Convenlng of Members' MeeLlngs
ln Lerms of secLlon 124 of Lhe AcL every publlc llsLed company ls obllged Lo convene a
sLaLuLory meeLlng where dlrecLors should presenL a sLaLuLory reporL lurLher every

company (boLh prlvaLe and publlc) should convene an annual general meeLlng (secLlon 123) where
speclflc buslness Lo do wlLh Lhe affalrs of Lhe company ls dlscharged AddlLlonally members have Lhe
power Lo call for or requlslLlon an exLraordlnary general
meeLlng 1hese varlous meeLlngs are slgnlflcanL ln advanclng corporaLe governance and
reduclng Lhe agency confllcL as Lhey asslsL ln brldglng Lhe lnformaLlon asymmeLry
exlsLlng beLween shareholders and managers Pow Lhls ls achleved ls dlscussed below
Annual 8eporLs and oLher ulsclosures

SecLlon 146 requlres managemenL Lo lay Lhe company's accounLs (le Lhe balance sheeL and Lhe
proflL and loss accounL slgned by Lwo dlrecLors) aL an annual general meeLlng of members An
exLernal audlLor's reporL should also be annexed Lo such accounLs lurLher and ln Lerms of secLlon
147 of Lhe AcL Lhere should be aLLached Lo Lhese accounLs a dlrecLors' reporL ouLllnlng Lhe sLaLe of
Lhe company's affalrs

SlgnlflcanL lssues of corporaLe governance arlse here LffecLlve corporaLe governance by company
boards requlres boLh good lnformaLlon and Lhe wlll Lo acL on negaLlve lnformaLlon 1he requlremenL
Lo dlsLrlbuLe Lhe company's accounLs and oLher reporLs Lo members forms Lhe hallmark of
Lransparency and accounLablllLy by Lhe agenLs Lo Lhelr prlnclpals As polnLed ouL earller ln Lhls paper
such dlsclosures are crlLlcal for Lhe advancemenL of corporaLe governance and for ensurlng LhaL
lnformaLlon asymmeLry ls reduced as beLween agenL and prlnclpal lurLher lL ls agreed LhaL Lhe
publlclLy whlch comes wlLh such dlsclosures places managemenL under compulslon Lo Lake
shareholder value maxlmlslng declslons as managerlal labor markeLs Lend Lo dlsclpllne poorly
performlng managers (kaplan and 8elshus 1990) 1hus Lhe plaLform afforded by sLaLuLory and oLher
meeLlngs and Lhe reporLs LhaL are presenLed aL Lhose meeLlngs glves shareholders an opporLunlLy Lo
assess noL only whaL" a company reporLs buL also why" parLlcular acLlons were Laken
ersonal LlablllLy of Cfflcers and AudlLors

Managers and company audlLors may noL afford Lo conducL Lhe affalrs of Lhe company recklessly as
dolng so would resulL ln personal llablllLy aLLachlng Lo Lhelr acLlons (see secLlon 190 of Lhe AcL)
lurLher ln Lerms of secLlon 189 dlrecLors are encouraged Lo have regard Lo Lhe lnLeresLs of Lhe
company's members prlnclpally Lo do wlLh proflL maxlmlzaLlon Powever Lhe weakness of Lhls
provlslon ls LhaL lL ls merely dlrecLory and noL perempLory/compulsory
LlmlLs on ower of ulrecLors

As a way of averLlng corporaLe scandals where dlrecLors would end up pre[udlclng Lhe shareholders
secLlon 183 (1) (b) of Lhe AcL prohlblLs dlrecLors from dlsposlng of Lhe underLaklng of Lhe company or
of Lhe whole parL of such company's asseLs wlLhouL Lhe approval of Lhe company ln a general
meeLlng 1hls llmlLs Lhe powers of dlrecLors Lo unllaLerally do as Lhey wlsh wlLh Lhe company's asseLs
hence prevenLlng Lhe posslblllLy of rlpplngoff shareholders 1hls way shareholders are proLecLed
from overzealous dlrecLors and managemenL
CLher / nonsLaLuLory proLecLlon avallable Lo Shareholders

AparL from Lhe sLaLuLory provlslons dlscussed above oLher measures are also avallable Lo be Laken
by shareholders Lo shleld Lhemselves from Lhe agency problems 1hese wlll now be consldered
below
AppolnLlng nonLxecuLlve ulrecLors

As sLressed above one of Lhe reasons for Lhe exlsLence of Lhe agency confllcL ls Lhe appolnLmenL of
board members who are also members of Lhe managemenL Leam (execuLlve board members) 1he
varlous reasons why Lhls ls so has also been dlscussed above 1o counLer Lhe negaLlve effecLs of a
board domlnaLed by Lhe managemenL Leam shareholders may conslder shlfLlng Lhe board
composlLlon ln favour of nonexecuLlve dlrecLors A nonexecuLlve board member would noL
normally sympaLhlze wlLh declslons LhaL are ln confllcL wlLh Lhe goal of maxlmlslng Lhe wealLh of
shareholders lama and !ensen (1983) argued LhaL effecLlve boards domlnaLed by nonexecuLlve
dlrecLors are beLLer able Lo separaLe Lhe problems of declslon managemenL and declslon conLrol
CuLslde dlrecLors are able Lo separaLe Lhese funcLlons and exerclse declslon conLrol slnce repuLaLlon
concerns and perhaps any equlLy sLakes Lhey mlghL have provldes Lhem wlLh sufflclenL lncenLlve Lo
do so
Managerlal and ulrecLor lncenLlves

lL ls generally agreed LhaL Lhe sLrucLure of execuLlve compensaLlon conLracLs can have a large
lnfluence ln allgnlng Lhe lnLeresL of shareholders and managemenL (McColgan 2001) CompensaLlon
conLracLs and Lhelr revlslon represenL a flnanclal lncenLlve for managemenL Lo lncrease company
value lL ls argued LhaL hlgher levels of such lncenLlves should be proporLlonaLe Lo hlgher company
performance (!ensen and Meckllng 1976) LffecLlve compensaLlon conLracLs should Lherefore provlde
managemenL wlLh sufflclenL lncenLlve Lo make value maxlmlslng declslons aL Lhe lowesL posslble cosL
Lo shareholders 1he maln forms of managerlal and dlrecLor compensaLlon are baslc salary
accounLlng based performance bonuses performancebased share opLlon schemes and longLerm
lncenLlve plans 1he effecLlveness of such lncenLlves largely depends on Lhe sLraLegy adopLed lor
example companles wlLh longLerm lnvesLmenL opporLunlLles should be expecLed Lo employ
compensaLlon plans wlLh conLlngencles whlch cause execuLlves Lo forfelL Lhe compensaLlon lf Lhey
leave Lhe company AccounLlngbased bonus schemes and performancebased share opLlon schemes
as modes of lncenLlves wlll now be dealL wlLh below
AccounLlng 8ased 8onus Schemes

8aslng bonuses upon accounLlng measures of performance provldes an lmproved mechanlsm for
allgnlng managers' lnLeresLs wlLh Lhose of Lhe company's shareholders (McColgan 2001) Powever
Pealy (1983) argue LhaL paylng execuLlves on Lhe basls of accounLlng varlables provldes an lncenLlve
for managemenL Lo dlrecLly manlpulaLe Lhe accounLlng sysLem and favour pro[ecLs wlLh shorLLerm
accounLlng reLurns aL Lhe expense of longLerm poslLlve nv lnvesLmenL 8onuses relaLed Lo
company sales may furLher encourage earnlngs reLenLlon and flrm slze growLh whlch doesn'L always
equaLe wlLh paymenL of dlvldends hence shareholder wealLh growLh AnoLher weakness ls LhaL
accounLlng bonuses may also lead Lo a focus on Lhe deLermlnlng varlables of Lhese compensaLlon
plans perhaps leadlng managers Lo neglecL oLher nonflnanclal aspecLs of performance llke
occupaLlonal healLh and safeLy soclal lnvesLmenL envlronmenLal lmpacL and developmenL and
skllllng of sLaff
erformance Shares

1he use of share opLlons ln execuLlve compensaLlon plans ls generally seen as Lhe one of Lhe mosL
effecLlve means of Lylng Lhe lnLeresLs of managers and shareholders under Lhls scheme shares are
offered Lo managers as a reward for performance whlch enhances shareholder wealLh Such opLlons
glve managemenL Lhe rlghL Lo buy company sLock aL a flxed prlce aL glven Llmes ln Lhe fuLure As
ownershlp of Lhe company by lnslde managers lncreases so Loo does Lhelr lncenLlve Lo lnvesL ln
poslLlve nv pro[ecLs and reduce prlvaLe perqulslLe consumpLlon 1he hlgher Lhe value of Lhe flrm
Lhe hlgher Lhe value of Lhe opLlons and Lhe proflL managers can make upon exerclslng Lhem Agrawal
and Mandelker (1987) reporL LhaL sLock opLlons encourage managemenL Lo make lnvesLmenL and
flnanclng declslons whlch lncrease Lhe varlance of Lhe flrm's asseLs AddlLlonally uenls eL al (1997)
flnd LhaL execuLlve ownershlp ls assoclaLed wlLh greaLer corporaLe focus lndlcaLlng LhaL Lhe severlLy
of Lhe managerlal rlskaverslon problem may be reduced Lhrough hlgher equlLy sLakes

Closely llnked Lo performance shares ls Lhe economlc value added LvA mechanlsm whlch can be
used Lo Lle managerlal compensaLlon Lo shareholder wealLh maxlmlzaLlon LvA ls Lhe performance
measure mosL dlrecLly llnked Lo Lhe creaLlon of shareholder wealLh over Llme A poslLlve LvA
lndlcaLes LhaL managemenL ls creaLlng wealLh for Lhe shareholders lL denoLes an esLlmaLe of Lrue
economlc proflL or Lhe amounL by whlch earnlngs exceed Lhe requlred mlnlmum raLe of reLurn
LhaL shareholders and lenders could geL by lnvesLlng ln oLher securlLles of comparable rlsk
CrlLlque of Lhe erformance Share scheme

Cn Lhe fllpslde share opLlon schemes may fall Lo provlde Lhe necessary lncenLlve due Lo Lhe
exlsLence of oLher facLors beyond Lhe conLrol of Lhe managers LhaL may affecL Lhe prlce of Lhe share
Lxamples are macroeconomlc facLors llke lnLeresL raLes lnflaLlon uncompeLlLlveness of Lhe
economy eLc whlch lead Lo a dlp ln share value lurLher evldence on Lhe beneflLs of managerlal
share ownershlp Lends Lo generally be mlxed Whlle Lhe LheoreLlcal argumenLs for lncreased
lncenLlves are unquesLlonable emplrlcal evldence suggesLs LhaL lnslder ownershlp may also come aL
Lhe cosL of enLrenchmenL Many facLors can lnfluence Lhe relaLlonshlp beLween lnslder ownershlp
and corporaLe value and as observed by McColgan (2001) recenL evldence Lends Lo suggesL LhaL
causallLy may even operaLe ln Lhe opposlLe dlrecLlon
1hreaL of flrlng

Accordlng Lo McColgan (2001) one of Lhe mosL conslsLenL emplrlcal resulLs ln Lhe corporaLe
governance llLeraLure ls LhaL dlrecLors are more llkely Lo lose Lhelr [obs lf Lhey are poor performers
ooresL performlng managemenL would lose Lhelr [obs aL Lhe lnsLance of dlrecLors moreso should
such poor performance be for prolonged perlods ln llghL of Lhls managers may be forced Lo Lake
shareholder maxlmlslng acLlons slmply ln order Lo keep Lhelr [obs and ln Lhe process proLecLlng Lhe
lnLeresLs of shareholders hence reduclng goal noncongruence beLween shareholders and
managemenL
8lock holder or lnsLlLuLlonal lnvesLors

1he exlsLence of large block lnvesLor(s) ln a company may overcome Lhe problem normally
encounLered by small aLomlsLlc shareholders who may noL have Lhe Llme sklll or Lhe lnLeresL Lo
monlLor managerlal acLlvlLles lnsLlLuLlonal shareholders are beLLer able Lo overcome Lhls challenge
as Lhey may have more sklll more Llme and a greaLer flnanclal lncenLlve Lo overcome Lhls freerlder
problem and closely monlLor managemenL AddlLlonally large shareholders may be able Lo elecL
Lhemselves onLo company boards lncreaslng Lhelr ablllLy Lo monlLor managemenL uenls and Sarln
(1997) conLend LhaL Lhe purchase of large share sLakes by ouLslde lnvesLors represenLs a conLrol
LhreaL Lo company managemenL and can provlde pressure for lnLernal governance sysLems Lo
operaLe more efflclenLly 8lockholder pressure may also deLer managemenL from nonvalue addlng
dlverslflcaLlon sLraLegles Slnce such lnvesLors already hold dlverslfled porLfollos furLher rlsk
reducLlons aren'L of lnLeresL Lo Lhem

lurLher lnsLlLuLlonal shareholders llke penslon funds muLual funds and lnsurance companles can
afford Lo exerL dlrecL lnLervenLlon 1he managers of Lhese lnsLlLuLlons usually have Lhe power and
Lake an acLlve lnLeresL ln Lhe managemenL of Lhe companles ln whlch Lhey hold shares 1hey can
lobby for Lhe lnLeresLs of all shareholders and suggesL ways ln whlch Lhe buslness may be run Such
dlrecL lnLervenLlon by shareholder represenLaLlves wlll lnfluence managemenL lnLo shareholder value
maxlmlzaLlon
ulsclpllnary 1akeovers

ulsclpllnary Lakeovers wlll occur ln response Lo breakdowns of lnLernal conLrol sysLems ln companles
wlLh large levels of free cash flows !ensen (1986) A hosLlle Lakeover ls llkely Lo happen when Lhe
shares of Lhe company are undervalued relaLlve Lo Lhelr poLenLlal due Lo poor managemenL Where
managers fear LhaL Lhey may lose Lhelr [obs followlng Lakeovers Lhey may reacL by lnvesLlng Lhese
free cash flows ln more efflclenL lnvesLmenL pro[ecLs Safleddlne and 1lLman (1999) flnd LhaL LargeLs
of falled Lakeover aLLempLs slgnlflcanLly lncrease Lhelr leverage ln Lhe perlod lmmedlaLely followlng
Lhe falled bld 1hese flrms Lhen Lend Lo sell off underperformlng company asseLs ln order Lo lncrease
focus on key proflLable lnvesLmenLs perhaps reverslng prevlously unproflLable dlverslflcaLlon pollcles
1hus Lakeover blds may be lnlLlaLed noL only for efflclency galns buL also as a way of dlsclpllnlng
poorly performlng managemenL
CrlLlque of Lhe ulsclpllnary 1akeovers

1he LhreaL of Lakeover alone would noL be enough Lo ensure compleLe coherence beLween
managerlal acLlons and shareholder wealLh 1hls can be aLLrlbuLed largely Lo Lhe cosLs of organlslng
Lakeovers ln parLlcular Lhe hlgh bld premlums (!ensen and 8uback 1983) Powever managemenL
may acLlvely seek Lo reduce Lhe probablllLy of Lakeover slnce lL may resulL ln loss of personal wealLh
and repuLaLlon Cne way of achlevlng LhaL would be
Lo lmprove proflLablllLy of Lhe flrm whlch ln Lurn would be beneflclal Lo shareholders
Concluslon

As has been shown above agency problems are real ln Lhe buslness realm 1he scope of each Lype of
agency confllcL wlll dlffer from one flrm Lo anoLher as wlll Lhe effecLlveness of governance
mechanlsms ln reduclng Lhem Powever hope ls noL losL for Lhe shareholder as varlous mechanlsms
may be employed boLh sLaLuLory and nonsLaLuLory Lo mlnlmlse Lhe damage Lo shareholder wealLh
caused by agency problems Lach Lype of governance and oLher mechanlsms dlscussed ln Lhls paper
can be lmporLanL ln reduclng Lhe agency cosLs of Lhe separaLlon of ownershlp and conLrol and afford
proLecLlon Lo Lhe shareholder


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