The Powers and Duties of the Directors of Companies in Light of the Agency Theory - Coursework Example

Student’s name) (Course code+name) (Professor’s name) (University name) Table of Contents 1.0.Introduction 2 2.0.Corporate Governance 4 3.0.Powers and Duties of Directors and the Agency theory 5 4.0.Implication of increasing shareholders’ powers in view of directors’ 13 5.0.References 17 1.0. Introduction Best Corporate Governance practices concerning listed companies have been widely researched with a view to increasing effectiveness of governance mechanisms. This essay finds that Corporate Governance has divergence and competing definitions---one of such is the Margaret Blair’s assertion as “…the whole set of cultural, legal and institutional arrangements that can be used to determine what publicly traded corporations are able to do, how that control is exercised, who controls them and how the returns and risks from the activity undertaken are allocated (Aguilera & Jackson 2003 p. 34). In as much, the contemporary scholars have attempted to narrow the expansiveness of the definition (Stout, 2008; Ghoshal, 2005; Gomez-Mejia et al. 2005). This has been so due to the ascendancy of financial markets and the intellectual domination as posited by the agency theory into an almost obsessive concern for the issues related to accountability and controls that are involved in the dispersal of ownership of the listed companies and a rigid focus on the mechanisms that can orientate duties of the directors of listed companies in light of the theory and still have some connectedness with powers of shareholders and directors. The underpinning of agency theory in this study guides the composition of shareholders and directors. It considers the existing relationships where responsibility can be delegated from seniors to agents. To show the effect of increase in powers, agents tend to assume to be self-interested and possess goals that are divergent from those of the seniors. Contemporary arguments posit that directors are accountable for the listed companies they govern (Mukwiri & Siems, 2014). High profile accounting irregularities, collapses, remuneration excesses, corporate corruption and inadequate disclosures practices attracted attention of scholars at the same time dented public confidence especially among listed companies and the implication on corporate governance. For instance, Daily and Dalton (2003) argue that activity and scale of corporations has been on increase immeasurably. That is, the governance of the concerned entities has assumed considerable importance. In so arguing, it remains that corporations have an impact on economies and societies---not just for their shareholders and directors, but stretches to the wider community they intend to serve. In as much, this study notes that Corporate Governance is multifaceted at the same time recognizes that this field has been making attempts to protect shareholders from selfish interests. It is for this reason that thesis statement of the research is to critically assess the powers and duties of the directors of listed companies in light of the agency theory and the effect of increasing powers of shareholders with regard to directors’. 2.0. Corporate Governance To understand the connectedness between powers and duties of directors of listed companies and agency theory, an understanding of Corporate Governance is essential especially in the wake of new dynamisms in business environment. Based on the assertion that directors tend to be self-interested and to some extend deviate from acts that benefit residual claimants, Corporate Governance is taken to mean mechanisms targeted at assuring existing shareholders that directors or managers will work hard to attain their interests (Chemers 2002). In broader approach, discussion of the powers and duties of directors’ vis-à-vis agency theory assumes four forces that are inherent in Corporations. These are: a. Capital markets b. Product and factor markets c. Political, legal and regulatory systems and d. Internal control systems as guided by directors Therefore an understanding of Corporate Governance intends to focus on internal and external mechanisms that aim at protecting the interests of its shareholders. 3.0. Powers and Duties of Directors and the Agency theory The first argument regarding the assessment of powers and duties of directors in light of agency theory is connected to adopt decision process framework as argued by Fama and Jensen (1983). While agency theory posits that modern corporations have share ownership being held and managerial actions attempting to depart from those needed to maximize shareholder returns, Fama and Jensen believe that corporations have a complex decision making process. These processes include: a. Proposal on resources utilization and contracts structuring b. Choice of decision that should be implemented c. Implementation and d. Monitoring Having these framework as proposed by Fama and Jensen, the question that scholars tend to ask is the one in which directors have powers and duties to undertake. Therefore with regard to the theory, Fama and Jensen assertions are still relevant. To conceptualise this view, Talbot (2013) argues that managers of listed companies have powers and duties to initiate and implement policies. Directors on the other hand, must allocate efforts to ratify decisions and monitor resource utilization so as to reflect the tenets and demands of agency theory. Reactions from Aguilera & Jackson (2010) show that it is unrealistic to look at directors as individuals who should be mandated with powers to make significant impact on policy decisions that impact business. Instead, they should just approve such decisions and occasionally provide advice or raise probing questions. The cornerstone of this assertion is that in accordance with agency theory, the principal has the mandate of limiting divergence from the interests and this is done by establishing necessary incentives for the benefit of agent and by taking care of monitoring costs designed to limit opportunistic actions undertaken by the agent. Conversely, Groyer (2010) concur that Agency theory is entirely concerned with listed companies and adds that this is done with unitary boards having operations in market systems. This assessment can help understand other dimensions regarding powers and duties of directors. He argues that powers and duties vested upon directors allow them to construct incentives and rules that can align the behavior of shareholders and mangers with the interest of owners also at heart. Groyer further posits that when such powers and duties are inherent among directors then the fundamental assumptions of a universal separation of control and ownership upon which the agency theory rests will have been upheld. This argument had earlier been discussed by scholars such as Pass (2004) adding that in United States which has been regarded as archetype of market based corporate system of governance has directors who are allowed to construct incentives and rules that can align the behavior of shareholders and mangers. Early researchers who opted to take managerial hegemony perspective to understand powers and duties of directors explained that directors have the duty of contributing towards strategy formulation of companies (Tosi, et al., 1994; Wagner, 1998; Wood & Patrick, 2003). Wood and Patrick in particular posit that powers vested upon directors should allow them work closely with management in order to devise strategic plans which in turn help in facilitating the monitoring functions. The school of thought agitating for this duty argues that as per agency theory, agents acts as opportunists who have hidden interests or associate with the company with bounded rationality---they will themselves make attempts to satisfy themselves rather than making attempts to maximize profits within the company. Connecting this statement with strategy formulation as expected of directors, agency theory is clear in its implications and underpinnings; there should be clear monitoring and control role from directors. This is where Groyer (2010) brings the aspect of strategy formulation so that such monitoring and control roles can be effective. This argument is well supported by Wood and Patrick (2003) when they say that strategy formulation is undoubted role of directors and such is supported by agency theory. The statement read, “…therefore the research finds that directors of listed companies have the role in strategy formulation since the theory (agency) emphasizes the crucial importance of such role. Such roles are allowed to allow company mitigates self-interests and setting of guidelines of implementing the chosen strategy.” (p. 171) In as much, Groyer (2010) questions Wood and Patrick that their argument is not gelling will with agency theory in the sense that the theory’s role regarding strategy formulation with respect to the role and or power of directors is not definite. Recent study by Stout (2008) further conceptualizes roles of directors as formulators of strategies essential in listed companies. He investigated top US and European listed Companies including Coca-Cola and Nokia and found that 45% of their directors are actively involved in strategy formulation. The research even categorized these kinds of involvement as Pilot, Trustee and Watchdog. Where under Watchdog directors should focus on evaluating and monitoring strategies after implementation; Trustee on the other hand is when directors plays limited role to initiate strategy but bigger one when analyzing and evaluating results. Lastly, Pilot role expects directors to play substantive role in all areas concerning strategy formulations. This research managed to categorize these progression of duties and powers as continuum; an aspect that can subsequently gain prominence in the normative literature and be connected to agency theory. The whole argument here when aligned with agency theory, was to come up with ways that could help companies ensure efficient alignment of interests between the principal and agent thus reducing the cost of agency. This argument coincides with what David et al. (1998) talked regarding purpose firm. Much of argument regards to Upland Brewing Company which faced the challenge of agents and principal due to self-motivated interests. As a result of this, principals should be challenged to come up with contracts that are able to protect interests at the same time maximize the utility in the event of conflict. Australian Securities and Investment Commission (ASIC) regulatory approach and directors of modern companies contend that in light of agency theory and interest of the companies, duties and powers of directors must be controlled and those exercised must be scrutinized (Sundaramurthy and Lewis 2003). In as much, they agree that powers and duties of the directors are to comply with the statutory duty of diligence and care. To expound on this, directors are supposed to discharge their element of diligence and care expected of a reasonable person and would exercise if they were a director of the mentioned company in the circumstance of the company. The assumptions underlining such power and duty circulation can be seen to be consistent with agency theory when argument by David et al. (1998) is factored in. By accepting that directors can discharge their element of diligence and care expected of a reasonable person means that managers of these Companies will always be there and their presence is self-interest and that such interests do not in some cases align themselves with those of shareholders. David et al. add, “This is why directors’ behaviors have to be monitored so as to ensure the company and shareholders benefit” (p. 25). Regarding the case study of AllianceBernstein Company where giving excessive powers led to low profits in stock market. It is therefore noteworthy from the argument of David et al. and on the other hand company AllianceBernstein Company that monitoring by other managers (termed as mutual monitoring by Fama and Jensen, 1983) has also been recognized by agency theory. This research also notes that agency theory recognizes roles of directors of listed companies but these roles have been left unspecified considering research that have been reviewed thus far. Therefore in light of Australian Securities and Investment Commission (ASIC) regulatory approach and directors of modern companies’ position on powers and duties of directors, there are some assumptions made by the agency theory regarding actors which in deeper scrutiny, does not augur well with powers and duties of modern listed companies as the theory is still tied to neoclassical economics. There are assumptions of utilitarianism, contractualism and individualism concerning agents which do not agree with the above powers and roles and do not even agree with powers and duties of directors in companies such as AllianceBernstein, Coca-Cola and Nokia where these companies are not allowed to be operated in a manner likely to suggest that shareholders act as per the criterion of utility maximization (self-interest). Observing the operations of companies such as AllianceBernstein, contemporary listed companies are so flexible to changes that assumptions made by agency theory for directors to adhere to are overtaken by events. In particular, he addresses the following agency theory assumptions that should be overlooked with regard to powers and duties of directors: a. Listed companies are nexus of contractual relationships b. Shareholders should be regarded as owners of listed companies c. The purpose of listed companies is to maximize profits of shareholders Mukwiri and Siems (2014) conflicts what has been seen by other researchers as key powers and duties of directors. Though they tend to bring aspect of management that will support shareholders in the wake of financial crises, their point of departure is that directors should be regarded as officers who make decisions on operation, financial budgets and accounting plans. This position conflicts with other assertions and indeed, assumptions named above in the sense that a common form of agency relationship as agreed by other scholars is the fact that directors are agents of shareholders, who by virtue of being a principal, obliged to seek returns on their respective investments. Therefore, by executing plans listed by Mukwiri and Siems, there is normative implication; which is the fact that directors maximize the net present value of the companies which according to the agency theory is the goal of shareholders. To this regard, the assumption that shareholders own listed company is not justified. Not because directors are tasked with the above plans but even within the premise or framework of agency theory, listed companies are nexus of contracts and therefore shareholders cannot own ‘a mere nexus’ (Mukwiri and Siems 2014). To make this argument palatable in light of the roles and powers of directors, contemporary business enterprises can distinguish between directors who make and execute decision regarding companies on the one hand and providers of capital on the other. This underscores directors as people who make decisions on operation, financial budgets and accounting plans. Turning to financial control as one of the powers and duties of directors, Daily and Dalton (2003) argue that directors should be allowed to take strategic decisions that are relative to the aims of the company. Such controls have been seen by scholars such as Eisenhadart (1989) to involve the concerned directors exerting the ‘episodic’ impact over shareholders and management but this must be done at the end of the resource allocation decision process. Qualitative researches that have attempted to penetrate corporate strategies argue that financial control is a point along a continuum (directors’ involvement in financial control is an inherent activity that should not be separated from them.) Nevertheless, research rooted in agency theory views such controls as a ‘rubber stamp’ approach to managing listed companies in the sense that it is a representation of managerial and shareholder hegemony perspective (Eisenhadart1989; Fich and Shivdasanti 2006). In as much, Fich and Shivdasanti warn that directors who entirely involve themselves in financial control exercise their legal and institutional powers but risk backlash from shareholders besides being classed as a de facto directing team. Agency theory does not question financial control by directors either. It only tends to do that in circumstances where researchers tend to make it look as universal in its nature and applicability. As a matter of fact, theory has been based on set of understanding and given theoretical streams like the shareholder primacy model that makes the theory consistent with directors’ ability to control finances in a company. Putting directors as financial controllers does to contravene interests of shareholders; in any case, directors are employees of shareholders under contract and therefore their position is not a privileged and as agents they have been accountable to their financial controls. Daily and Dalton (2003) say ‘…there have been transformations in the field of Corporate Governance and as directors; there are more daunting tasks than at any other time in business history’ (p. 36). According to this assertion, it means duties and powers of directors have ceased from being specific but dependent on nature and environment under which the business operates. This has been escalated by growth in potential risks, a greater personal commitment that are needed of an ever complex business. Therefore, their arguments tend to be headed to dominant theories related to Corporate Governance; agency theory, shareholder theory and managerial hegemony theory as examples of such. In as much, it is their approaches of agency theory that help this assessment realize yet another power and duty of directors of listed companies. That is, agency theory adopts an economic model of action therefore placing directors as people who should be tasked with powers and duties of ensuring economic stability in the company. Basically, this point of view insinuate that there is an endorsement of moral skepticism and therefore in view of other scholars, not a good point of departure for the growth of a system applied ethics such as listed companies. Furthermore, arguing that agency theory places enormous powers on directors to be stabilizers of economy in listed company is tantamount to adopting certain line of economic model of action which according to the actual definition of the theory, makes an assumption that directors act only from egoistic and not altruistic motives. This point can be made succinctly observing that though directors have the duty and powers of ensuring listed companies run on healthy economic ground. That is, it is not the interest in the directors that should be equated to their economic role in these companies but the economic rationality that drives them. It is their ability to manage finances that make directors have the powers and this also provides the basis on which one can make rational choice and action. Agency theory opens platform for theorists, shareholders, directors and criticisms to learn that principal-agent theory (as an aspect of agency theory) may be merely concerned about how directors manage circumstances involving ‘goal incongruity’ between two or even more persons. Therefore it does not matter whether directors may be selfish in pursuit of their duties and powers; what matters is that each acts as rendered in pursuit of her or his own gains or goals, and that such gain and or goals show up only insofar they impact that ability to satisfy these goals. In view of directors being given power and duty to act as economic powerhouse of listed companies, ethicists have come up with different argument suggesting that agency theory is a good example of anodyne. This is when Allan Buchanan gives articulation when he posits that: “if in the application of principal/agency theory that directors must be given powers and duty to manage economies of companies then the assumption is that motivation is exclusively self-interested. However, the best ground to proceed from is that the conflict of interest that has been giving rise to agency-risks can be allowed to result from a variety of motivations on that side of principals and agents.” 4.0. Implication of increasing shareholders’ powers in view of directors’ Current efforts in Corporate Governance has been focusing on making shareholders replace directors with recent debates focusing on implication of providing shareholders with more powers to replace unwanted directors in ballot thus rationalizing agency theory especially when shareholders are convinced that agency-principal rules are not adhered to. Fich and Shivdasanti (2006) fault powers of shareholders under United States corporate law where they see considerable loopholes of shareholders in Companies such as Coca-Cola when legal rules continue to insulate directors from shareholders intervention. Therefore Corporate Governance needs overhaul by first providing shareholders with the power that can make them initiate and approve some major decisions in Corporate Governance. A central and well-documented principle of United States corporate law agitate for major corporate decisions to be made or to say the least, initiated by the board thus ignoring shareholders---the same case in Canada and Japan (Aguilera and Jackson 2010). This section therefore finds that increasing shareholder’s powers vis-à-vis directors’ is desirable and greatly conceptualizes the tenets of agency theory. The major corporate decisions that have been reviewed for which increasing shareholders powers are based can be grouped in three categories. These three categories are for which increasing shareholder powers vis-à-vis directors’ is worth discussing. The three categories are: a. Rules of the game-increasing the powers so that there could be amendments to the corporate charter or change the state of incorporation in the company b. Game ending-shareholders having powers to decide on merging, selling assets or dissolving listed companies c. Scaling down-increasing powers so that shareholders can contract the size of the company’s assets through ordering a kind or cash distribution. Starting with game ending, increasing powers of shareholders will tend to end long-standing principles of corporate laws which have been denying shareholders decisive say with regard to all decisions made by directors. In as much as game ending and rule of the game require a vote of shareholder approval, such vote is not essential as directors can initiate such vote thus construing presence of shareholders. It therefore goes that increasing powers of shareholder would mean a game changer for directors in terms of approving directors. In as much, it needs to be noted that Corporate Governance does not render shareholders completely powerless especially listed companies that tend to buy the idea of agency theory. In most companies, shareholders have powers that enable them vote on the election of directors thus making these companies exercise what he terms as ‘representative democracy.’ This is the bone of contention; increasing shareholders power will make them cease from being representative but acting directly in the process. The underlying view according to this statement is that shareholders’ powers increase means that board of directors can be replaced not to mention decisions being attentive to the wishes of such shareholders. On the other hand, argument from Talbot (2013) explains why the powers to veto fundamental corporate changes and powers to elect directors are insufficient to ensure that shareholders have their way. This augurs well with group three (scaling down). The practical essence of this argument is that there could be situations where shareholders wish to make decision that opposes directors’ decision. This is the time where increase on their powers would mean that directors work under the caution and supervision of shareholders. In view of agency theory, the relationship between the principal and agents will be actively represented especially when attempts to eliminate egoism and self-centered motives. Chemers (2002) reviews this case and argues that established companies find it hard to completely give shareholders powers that supersede that of directors. His point of concern is that such companies have their directors ‘classified’ meaning that only a third of its members can be changed during annual elections. A practical example is Nokia Company where increasing the powers of shareholders or even making them have veto fundamental corporate changes do not enable such shareholders to have effect fundamental change---whether merger, dissolution or charter amendment (especially where directors prefer status quo). But Chemers (2002) concludes that any increase in shareholders powers would ultimately conceptualise agency theory and make shareholders have powers to intervene and make differences in corporate outcomes. In a separate argument, Aguilera and Jackson (2010) posit that increasing powers of shareholders vis-à-vis directors would itself make sure that arrangements that have been made to govern any other listed company does not depart from the ones created to take care of shareholders. With shareholders powers being increased, it means more interventions, powers to change dealings in the company without having interventions legally. For instance, shareholders in United States of America were concerned about the recent governance failures where they were blocked from making amendments with regard to separation of powers between the CEOs and the board positions. It also needs to be noted from the recent case of AllianceBernstein that since directors have superior information; shareholders will still be better placed if directors always make corporate decisions. Giving shareholders more powers, especially to intervene, does not mean that directors’ information would be futile or unused. In means that shareholders will only intervene in cases where agency theory or agent-principle is not respected. Therefore increasing shareholders powers in justified in the current corporate governance environment. Failing to grant such powers is retrogressive and tantamount to paternalistic approach which is unlikely to augur well with either current capital market and agency theory. 5.0. References Attached in a different sheet kindly find it Read More