Corporate governance - What are the arguments for and against agency theory as a basis for understanding corporate governance?

Résumé du document

Corporate governance and the theory of the firm are two of the fastest growing topics in modern economic theory. Berle and Means argued that modern corporations were so dependent upon professional managers that a managerial economy had emerged, characterized by the separation of ownership from control in corporations. The managers decided upon the running of the corporation whilst the shareholders, though they were the owners, were only entitled to receive cash flows. This leads to potential conflicts between the interests of the shareholders and those of the management. Following these two pioneering works, significant contributions have since been made in the areas of property rights theory (Hart and Moore, 1990), agency theory (Jensen and Meckling, 1976), the theory of incomplete contracts (Williamson, 1985), and transactions cost theory (Williamson, 1985). All these theories contribute from different angles to an understanding of the issues of corporate governance, and fundamentally affect our thinking about what is a firm and in whose interests the firm is governed.

Extraits

[...] (1987),'The Relation between Price Changes and Trading Volume: a Survey', Journal of Financial and Quantitative Analysis22, 109- Kay, Johnand Aubrey Silberston (1995), 'Corporate Governance', National Institute Economic Review84, 84- Williamson, Oliver (1985), The Economic Institutions of Capitalism, New York: Free Press. [...]

[...] The first one is through an incentive scheme to tackle the unobservable managerial effort and the moral hazard problem arising from it. According to Holmstrom (1979), managers may slack off when shareholders do not know how hard they work. To elicit higher effort, shareholders should provide managers with incentives to work hard, in part through share ownership. If managers are risk-neutral, then in general it is optimal for them to own 100 per cent of equity in the companies they run. [...]

[...] The shift out of profits and into managerial discretion induced by the dilution of ownership is responsible for this loss. For example, in a large firm (e.g. a corporation) the manager usually owns only a fraction of the shares due to wealth constraints and/or risk aversion. When the manager owns, say, only 10 per cent of the company, he pays for a dollar of perquisites with only 10 cents of his own forgone profits, and hence will overconsume perquisites. Of course, there may be mechanisms for keeping down the consumption of perquisites, such as oversight by boards of directors, the managerial labour market, takeovers, and so on. [...]

[...] In such a situation the principal agent contract becomes one of growth in share value for the shareholder and rewards for the manager but all expressed in the present and without any regard for the future of the business. Thus the business can become not an entity in which the managers are expected to be concerned with stewardship but rather a cash cow to be managed for immediate benefit shared between the managers and the owners with little regard for anyone else. It is argued here that the reliance upon agency theory as a mechanism for managing a business is one of the problems which leads to the excesses referred to at the start of this article. [...]

[...] Since the interest of the agent is not always in line with that of the principal, the agent may act for himself even though his actions will harm the interests of the principal. To ensure the agent works properly for the principal, the principal has to incur extra costs (non- pecuniary as well as pecuniary) - these are called the agency costs. Jensen and Meckling (p. 308) listed the agency costs as the sum of: 1. the monitoring expenditures of the principal; 2. [...]