Agency costs, corporate

governance and their link to

institutions
Emerging Markets
2019
Jakob Arnoldi
Learning goals:
1. Understand basic tenets of agency theory;
• opportunism;
• control issues in organizations with division of managerial labour and
delegation of control.
2. Relate agency costs to issues of institutional efficiency.
3. Begin an understanding of how P-A problems are overshadowed by
P-P problems in emerging markets.
A recap: Transaction costs

• Problems (costs) involved in transactions

• These costs associated with issues of:
• Frequency Two main forms of
• Asset specificity governing/coordinating
• Uncertainty transactions: Contracts and
• Opportunism hierarchy.
• Information asymmetry

Institutions can help coordinate transactions and reduce uncertainty

Agency costs
• Concerned with alignment of interests and coordination of actors
(individuals) – primarily and originally within organizations.
• Costs of hierarchical control?
• Originates in issues regarding separation of ownership and control –
corporate governance.
• Link between TCE and Agency Theory (AT): Opportunism (self-interest
with guile)
• Link between AT and Inst. Theory: Institutional efficiency can reduce
agency costs.
 Agency Theory
(Principal-Agent Theory)
Principal Example:
Owner/shareholders

Delegation
(Contract)

Example:
Agent Managers/employees
(any employment relationship)

Basic question: How can the interests of the principal be maintained when control is
delegated?
The modern corporation:
• Distributed ownership.
• Professional management.
• Separation of ownership and control.

ENTER: Corporate
governance
Agency Theory
(Principal-Agent Theory)
• The agency problem
• Pre-contractual (hidden information)
• Post-contractual (hidden action)
• Assumptions:
1.Self-interest motivate both parties
2.Incomplete information
(information asymmetries)
3.Realized outcomes partly determined by
environmental factors
4.Different risk preferences and conflicting goals
The solution to agency problems
• Contracts
• Incentives.
• Monitoring (accounting, financial statements etc.).
• Boards.
• Regulation.
Corporate governance.

• How corporations are defined, controlled,

and regulated.
• How ownership is defined, in which forms and
with which rights. Legal
• How accountability and transparency is ensured. framework (or
• How corporations fulfill responsibilities to institutions!!!)
various stakeholders.
• Which contract mechanisms best sustain
Ergo: Institutions
corporations (links to corporate finance). can reduce ACs
Key themes in corporate governance
(research)
• Problems of control and monitoring: fraud, lack of accountability,
conflicts (of interest) between different owners or between owners
and managers generally.
• Problems of regulation.
• Different systems of regulation across nation states. Different
perceptions of whom the firms should be accountable to and for:
Shareholders (only) or (also) stakeholders?
• Consequences for strategic priorities of firms: How is firm strategy
influenced by its system of corporate governance?
Corporate governance in emerging markets
(3rd learning goal)
• Corp. Gov in Emerging Markets generally less developed because
corporate governance hinges on formal institutions.
• Informal means of control:
• Concentration of ownership.
• More inter-firm ties.
• More family ownership.
• RESULT: Agency problems tend to be of a different type.
P-A PROBLEMS
Principal – agency problems
Separation of ownership and control; mature economies; shareholder models; fragmented ownership.

Principal Principal Principal Principal Principal Principal

(owners) (owners) (owners) (owners) (owners) (owners)

Information
obstacles/conflicts

Agent
(manager)
P-P problems
Principal – Principal problems
Emerging markets; concentrated ownership; family ownership.

Principal:
Principal: minority
Conflict
Majority owner owners

Agent
Principal-Agent vs. Principal-Principal

Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D. & Jiang, Y. 2008. Corporate Governance in
Emerging Economies: A Review of the Principal–Principal Perspective. Journal of Management
Studies, 45 (1): 196-220.
Main cause of conflict:
Expropriation of minority shareholders

How?

Transfer of resources away from the firm - to another firm also under the control of the majority
shareholder/owner

Why ?

If the majority shareholder has greater ownership stake in the other firm, then loss is shared with
minority shareholders in one firm, while gains in the other firm are enjoyed more exclusively by
the majority shareholder/owner.
Example
100%
Mr X.
Firm B
50.1%

Firm A
Pyramidal ownership structures can increase
gains
Mr X
100% 100%
50.1%
Firm D Firm E
Firm A
50.1% X’s cash flow rights in Firm E =
100%
Firm B
50.1%
Firm C

X’s cash flow rights in Firm C =

12,6%
Types of expropriation
• Self-beneficial trades (manipulated transfer prices).
• Loans and loan guarantees.
• Advancing family or friends.
Why more expropriation (P-P) in emerging
markets?
• Weak institutions.
• Concentration of ownership.
• Pyramids.
• Family ownership.
Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D. & Jiang, Y. 2008. Corporate Governance in Emerging Economies: A Review of the
Principal–Principal Perspective. Journal of Management Studies, 45 (1): 196-220.
 The Franchising/
Bestseller-case

Franchising can be defin ed as a continuing relationship in which a franchisor provides a licensed

privilege to the franchisee to do business and offers assistance in organizing, training,
merchandising, marketing and managing in return for a monetary consideration. Franchising is a
form of business by which the owner (franchisor) of a product, service or method obtains
distribution through affiliated dealers (franchisees). The idea is that both parties can earn a profit
by copying a business concept again and again. The franchisee pays a franchise fee (typically
between 5 and 10 percent of turnover)to get the right to do this. The companies are in this way
assumed to be ab le to open new stores rather fast, also in new international markets .

Questions:

Why is franchising considered as a viable way of organizing according to the view of organizational
economics? What are the conditions? Some years ago the Danish company, Bestseller, decided to drop
franchise in China. .Bestseller will renew its business model in China, so that
there will be a significant reduction in the number of franchise stores. Why (do you think)?
Dias 21
Summation
• Agency cost = cost of monitoring and control of managers or cost
inflicted on minority owners by majority owners.
• Classical form: P-A
• Emerging markets: P-P
• Overall result: barrier for growth (just like transaction costs)
• Best remedy: institutional development.
• Substitutes: family ownership, concentrated ownership, state
ownership, business groups (but these carry p-p costs).