Agency Conflicts and Corporate Governance

Agency Conflicts and Corporate Governance
December 9th,
2021 Babandi Ibrahim Gumel, DBA
Purpose of the Presentation
 Introduce agency conflicts
 How to reduce or eliminate agency conflicts
with corporate Governance Policy.
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At the end of the presentation,
Learners will understand:
 Example of Corporate Governance (Citigroup 2007-2012)
 Agency Conflicts
 Conflicts between stockholders and creditors
 Conflict between Inside Owner/Managers and Outside Owners
 Conflict between Managers and Shareholders
 The behaviors of managers that will harm the intrinsic value of
a firm
 Corporate Governance
 The internal control provisions for corporate governance
Example of Corporate Governance (Citigroup 2007-2012)
2007 – CEO Vikram Pandit had wild ride regarding
Compensation, where he sold his hedge fund to Citi
group and made $167 million profit.
In late 2007, Pandit was appointed CEO of Citi with cash
pay of $1.2 million and over $19 million in stocks and
options.
Due to global economic crisis of 2008, Pandit offered
and took $1 in salary in 2009 and 2010.
In 2011, as things improved, Pandit received a base
salary of $1.75 million and retention bonuses of $23
million …….Continued
Continued
In 2012, the board of Citi recommended a salary
increase to $15 million to Pandit, plus a bonus plan
recommending top five executives could earn up to $18
million if the combined income of Citi exceeded $12
million.
Angrily, the shareholders of Citi voted against the
proposed compensation plans.
The shareholder's reaction was prompted due to the
2011 pretax income earned by Citi which legitimized the
proposed bonus even if Citi lost $7 million pretax income
in 2012
Continued
The Board members of Citi considered the voted of the
shareholders as non-binding and ignored the vote.
Large Shareholders of Citi sued the board for breach of
duty.
This is one of similar incidences happening around the
globe and should be taken seriously when handling
corporate governance policies.
Listeners of the webinar are advised to keep this in mind
while we roll through the presentation.
Source: Francesco Guerrera, “Citigroup’s Pay Fiasco: Wake-Up Call Board,” The Wall Street
Journal, April 24, 2012, p. C1.
Corporate Governance and Corporate Valuation
1. Managers 3. Choices a firm

made regarding
operations and In turn
M
a financing affect
4. Free-Cash-
Flow
k
e
The decisions affects

D
Affect
e
c
i
s
i
o
n
5. The Maximization of the
O Value of Stakeholders
n
2. Operations, Financing, and many

other organizational characteristics
Steps of Agency Conflicts
One Person Company – Owner/Manager
Corporate Governance reduce or

No Agency Conflict Possible
eliminate Agency conflicts

Owner Hire Employees
Situation Changes with likelihood of conflicts
Owner Hires Some One to Run The Affairs of the Firm

The Situation Changes with more likelihood of conflicts
When owner invited outsiders to invest and even went further to invite creditors
The situation changes with conflicts between owners, managers, employees, and
creditors
Agency Conflicts
 In a situation where a founder or owner of a business
serves as the overall manager of an organization, It is
unlikely for such an organization to have agency
conflict.
 When the owner started to employ people to work in the
firm, the situation changes:
 The conflict increases if the owner sell shares to an
outsider or employed someone to manage the affairs of
the firm.
Sole Owner/Sole Worker
 The owner will reap
the benefits accruing
to the organization
 At the same time will
take all the liabilities
of the firm.
 Agency Conflict is
unlikely.
Owner With Hired Employees
• Because the owner will
not share the full benefits
and losses with the
employees: The firm
become vulnerable to
conflicts.
Corporate Entity
• Because of new
shareholders, board, and
management: Conflict
arises between owners,
employees, managers,
and the creditors to a
firm.
AGENCY CONFLICTS - OVERVIEW
Agency Conflict The agency conflicts are incidences that occur when owners
Defined authorized other people to manage firms on their behalf.
Agency Relationship The agency relationship come into effect whenever a person
(principal) hires another individual (called an agent) to act on his
behalf and perform services with the delegated authority of
making decisions.
Agency Conflicts Agency conflicts results in increased costs leading to reduction
Costs in a firm’s value.
Types of Agency Conflicts between stockholders and creditors

Conflicts that increase Conflict between Inside Owner/Managers and Outside Owners
Costs Conflict between Managers and Shareholders
Conflicts between stockholders and
creditors
 This Kind of agency Conflicts resulted in additional costs to a
firm in two ways:
Increased leverage - Increased leverage is

Assets switch - Assets switch is when a firm
when a firm borrows and issue additional
sells its assets and invest in high profitable
bonds that can be used to repurchase the
risky project which will result in increased
outstanding stock
risk exposure to creditors
Ways to minimize the costs associated
with Agency conflicts.
 There are two ways to minimize the costs associated with
agency conflicts arising between stockholders and creditors:
• from
Creditors may charge high interest rate to
By writing debt covenants detailing the
compensate increased risk they are likely
actions a firm can take and not to take.
exposed to
Conflict between Inside
Owner/Managers and Outside Owners
• from
After the motive of increasing
the wealth of the firm, an
owner/manager is bound to
increase perquisites (leisure
time, luxurious offices etc.), and
when owner/manager sell stocks
to outside owners, potential
conflict might arise as a result of
increased perquisites.
Conflict between Inside Owner/Managers and Outside
Owners Costs
The conflict due to

perquisites leads to cost
resulting in low stock price to
outsiders; and is why dual
class stock, that does not
have voting rights has less
price than the one with voting
rights.
Avoiding the perquisites will reduce or eliminate cost and the impact.
Conflict between Managers and Shareholders
 Shareholders hire competent managers with the view to maximizing the value of
the firm, the managers might focus on satisfying their interest rather than value
maximization, which will make the corporate value to decline.
Maximizing the
With value of the firm
Shareholders the Make the
hire competent view of corporate
managers
value to
decline
They y
Focu Satisfying their The on
s on us
interest rather Foc
than value
maximization
The behaviors of managers that will harm the
intrinsic value of a firm
The behaviors of managers that will harm the intrinsic value of a firm include:
Spending less time and less effort on activities that will maximize the value of the firm.
Rather than use the fund of a firm on the activities of the shareholders, some managers behavior is to use funds to satisfy their own
need such as lavish offices and corporate jets etc., called nonpecuniary benefits.
Managers avoid value adding but difficult decisions that may harm their friends.
Avoidance of taking too much or enough risk by managers result in skipping the right project that will
add value due to fear of been sacked or having a distorted image.
Firms with positive FCF can have managers that stockpile in the form of marketable securities, instead of returning
it to investors for possible investment in good opportunity growth firms.
Managers tend to hold certain vital information needed by investors, if such habit is established, investors are likely to discount the
expected free cash flows at higher cost of capital resulting in reduced intrinsic value of the firm.
CORPORATE GOVERNANCE
 Corporate governance is defined as
“the set of laws, rules, and procedures
that influence a company’s operations
and the decisions its managers make”
(Brigham & Ehrhardt, 2014, p. 528).
 Agency conflicts can decrease firms’

value of stock owned by outside
shareholders.
 Corporate governance can reduce or

eliminate such conflicts thereby
mitigating the loss in stocks value.
PRINCIPLES OF CORPORATE GOVERNANCE
There are ten principles of corporate governance:
1. Lay solid foundations for management and oversight.
2. Structure the Board to add value
3. Promote ethical and responsible decision-making
4. Safeguard integrity in financial reporting
5. Make timely and balanced disclosure

6. Respect the rights of shareholders
7. Recognize and manage risk
8. Encourage enhanced performance
9. Remunerate fairly and responsibly
10. Recognise the legitimate interests of stakeholders
Pathway to Excellent Corporate Governance
There four factors that contribute to an excellent corporate governance:
Accountability Corporate accountability refers to the obligation and responsibility to

give an explanation or reason for the company’s actions and conduct.
Responsibility The Board of Directors are given authority to act on behalf of the
company. The board should therefore accept full responsibility for the
powers that it is given and the authority that it exercises.
Transparency Transparency means openness, a willingness by the company to provide

clear information to shareholders and other stakeholders: Stakeholders
should be informed about the company’s activities, what it plans to do in
the future and any risks involved in its business strategies.
Fairness Fairness refers to equal treatment, for example, all shareholders should
receive equal consideration for whatever shareholdings they hold.
THE CORPORATE GOVERNANCE PROVISIONS ARE EITHER CARROTS OR
STICKS.
 The stick - is the threat of removal as a

result of hostile takeover or as a result
of the decision of board of directors.
 The Carrot - if the managers of a firm
are maximizing the value of the stock,
they need not to worry about being
removed. Managers are offered
incentives when they maximize the
intrinsic value of the stocks which are
part of the carrots approach. Thus,
managers are compensated as most
firms link performance to
compensation.
 Some of the corporate governance
provisions are for internal control of a
firm.
THE INTERNAL CONTROL PROVISIONS
The internal control provisions are
divided into five:
Board’s monitoring and discipline
Bylaws provisions that effect the likely
hostile takeovers of the firm
Compensation plans
Accounting control systems
Capital structure choices
MONITORING AND DISCIPLINE BY THE BOARD OF
DIRECTORS
 Shareholders being the corporate owners of an
organization elect the members of the board who act as
agents on their behalf.
 In US, Nigeria, and other countries, their duty includes
monitoring senior managers where they discipline them
if they do not act on behalf of the shareholders through
removal or reduction of compensations.
 In Europe, an employee representative is included in
the board
 While in Asia, banks have representation on the board.
DIRECTORS CONTINUED …..
 Areas needing monitoring and discipline include:
 The board of directors have a nominating committee and only
candidate nominated by the committee are on the ballot. In most
cases the CEO is the also the chairman of the board and
influences the nominating committee.
 In most cases the management control the 51% of the shares
enabling them to control the voting process.
 Also most of the members of the board are insiders (people with
managerial responsibilities).
 The system that mitigated this problem of insiders control is the
requirement of NASDAQ and NYSE in US that require majority of
board members to be outside the firm.
DIRECTORS CONTINUED……
 Studies suggested that corporate governance improves if:
 The CEO is not chairman of the board, majority board
members are business experts from outside
 Membership of the board is not too large
 Compensation of board members is appropriately (not
too high, not all cash, with exposure to equity risk
through options or stock)
CHARTER PROVISIONS AND BYLAWS THAT AFFECT THE LIKELIHOOD OF
HOSTILE TAKEOVERS
 In a situation where managers are not able to increase the free cash
flows of a firm, another company can acquire the firm, change the
management, and turn the company around with increased free cash
flows.
 Targeted repurchases can be banned through a shareholder friendly
charter also known as greenmail.
 The charter does not contain a shareholder rights provision otherwise
called poison fill.
 The provision of a poison fill will prevent taking over of the company
which will helps entrench management.
 The restricted voting rights in the provisions also entrench
management of a firm.
ENVIRONMENTAL FACTORS OUTSIDE A FIRM’S CONTROL
Regulations and laws of agencies such as SEC

which are often treated with heavy fines in case
of non-compliance,
The laws in the legal system including
environmental regulations and laws.
Other external factors include competition with
other firms, block ownership patterns and the
issue of media and that of litigations
CAPITAL STRUCTURE AND INTERNAL CONTROL SYSTEMS
The capital structure of a firm can affect the

managerial behavior of a firm.
As the level of debt increases, the threat of bankruptcy
opens and affects managerial behavior.
A high debt may lead to managers avoiding high risky
project that will increase the value of the firm thereby
underinvesting problems reduces the value of the firm.
Firms decides on optimal capital structure to avoid the
likely incidence of bankruptcy in an organization.
Corporate Governance Reduces or Eliminate
Cost Associated with Agency Conflicts
thereby Maintaining the Value of a Company.
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31
TEST
1.An Increased perquisites by managers might result in conflict

between,
a. Inside managers and board of directors
b.Financial manager and human resource manager
c. Inside owner/manager and outside owners
d.Bank officials and financial manager
e. None of the above
TEST
2. One of the following is a way of minimizing cost associated with agency conflicts
arising between shareholders and creditors.
a. Managers to collect more loan and pay less interest rates over a minimum
number of years
b. Owners/managers to pay for risk and avoid it totally
c. Creditors may charge high interest rate to compensate risk they are likely
exposed to.
d. Managers charge high interest rate and deal with the differences of payment
later.
e. Expose the cost to bank instruments for possible liquidation
f. All the above
TEST
3. One of the followings is not true about agency conflicts

a. Owner hires someone to run the affairs of the firm: The situation
changes with more likelihood of conflicts
b. Owner hire employees: Situation changes with likelihood of
conflicts
c. One person company – owner/manager: No agency conflict
possible
d. Corporate governance reduces or eliminate agency conflicts
e. Agency conflict can be handled by customers
TEST
4. Which of the following is not a principle of corporate governance?

a. Recognition of the legitimate interests of stakeholders
b. Fairly and responsible renumeration
c. Promotion of ethical and responsible decision
d. Travelling for consultation with outside owners
e. Laying solid foundation for management and oversight.
TEST
5. Which of the following is one of the four factors that contribute to

an excellent corporate governance?
a. Transparency
b. Conditioning
c. Oversight
d. Auditing
e. Authority

QUESTION AND
ANSWERS
SESSION
THANK YOU!
• Phone: +2348032872204
• Email: bbdgumel@gmail.com
Dr. Babandi Ibrahim Gumel
www.ligsuniversity.com
References
 Brigham, E. F. & Ehrhardt, M. C. . (2016). Corporate finance: A focused approach . Cengage
Learning.
 Chandra, P. (2018). Financial management: theory and practice. Mc Graw Hill India.
 Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2011). Corporate financial management: Bridging the
gap between theory and practice. Wohl Publishing.
 Fabozzi, F. J., & Markowitz, H. M. (2011). The theory and practice of investment management. John
Wiley & Sons, Inc

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Agency Conflicts and Corporate Governance

1. Managers 3. Choices a firm

The decisions affects

2. Operations, Financing, and many

Corporate Governance reduce or

eliminate Agency conflicts

Owner Hires Some One to Run The Affairs of the Firm

Types of Agency Conflicts between stockholders and creditors

Increased leverage - Increased leverage is

The conflict due to

 Agency conflicts can decrease firms’

 Corporate governance can reduce or

1. Lay solid foundations for management and oversight.

2. Structure the Board to add value

3. Promote ethical and responsible decision-making

4. Safeguard integrity in financial reporting

5. Make timely and balanced disclosure

10. Recognise the legitimate interests of stakeholders

There four factors that contribute to an excellent corporate governance:

Accountability Corporate accountability refers to the obligation and responsibility to

Transparency Transparency means openness, a willingness by the company to provide

 The stick - is the threat of removal as a

Regulations and laws of agencies such as SEC

The capital structure of a firm can affect the

1.An Increased perquisites by managers might result in conflict

3. One of the followings is not true about agency conflicts

4. Which of the following is not a principle of corporate governance?

5. Which of the following is one of the four factors that contribute to

Dr. Babandi Ibrahim Gumel

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