Day 194 The agency issue

The agency issue

The corporate governance is the system used to manage the corporation. It determines the structure of the company. Generally, the shareholders elect a board of directors as the corporation’s controller, and professional managers are hired to participate in the business daily operations. The manager’s responsibility is to ensure that the company reaches the maximum value by achieving the commercial goals. Therefore, the owners/shareholders' wealth can be maximized as well. However, there are many factors that may prevent the manager to behave in such manner. These conflicts between the management and the owners are referred as the agency cost. 

In fact, the manager can be considered as an agent employed by the owners to monitor the company on their behalf. The shareholders entrust the management team that they will act to maximize the capital value. Although most of the managers are willing to perform in such way, their passion may be chilled-down when the decision confronts in conflict with their personal benefits. The causation can be the fear to lose the job, private wealth, perquisites and individual preference. For example, the manager may want to use the company vehicle for personal use, apply for reimbursement for their individual expense, or provide unethical financial reports to secure their position. This agency problem creates the negative effect on both the company’s profit and the trusting relationship between shareholders and management group. We all know that as a rational person, our behavior is directed by the cost-benefit principle. Hence there are two approaches to solve the agency issue, to implant cost on these misdeeds or create incentives to encourage managers to act correspond to the standards of conduct. The cost for the poor performance is the possible replacement of the management. The voting of shareholders or the take over by the competitor can induce this consequence. On the other hand, the corporations can provide incentives to prompt the manager’s enthusiasm. Which is called the management compensation or the executive compensation. This is the bonus to reward well performing managers. It gives the manager financial incentives to act in the best interest of the owner. Basically, there are two different plans to propel manager’s performance. The incentive plan binds the compensation to the company’s stock price. For example, the share option is a reward for managers to purchase company’s shares at an exercise price. Thus the manager will tend to work harder in order to increase the value of the shares. Another method is the performance plan, which the manager’s performance is evaluated by certain figures such as earnings per share. Once this goal is achieved, the manager will be granted with shares of the company or receive cash bonus. 

Even though most of the financial companies implement this manager compensation system, the argument of it has been the instrument of the executive team to create their personal benefit never ended. Nonetheless, most of these companies refuse to cancel or deduct the amount of compensations even during the recession of Australia in 2008.