Agency Theory and Its Implication On Corporate Governance

Agency Theory and Its implication on
corporate Governance
- A contract under which one or more persons (shareholders) engage another

person/s (directors) to act on their behalf, delegating decision making authority
- If both parties are utility maximizers… agents will

tend to act in their own interests and not always
in the best interest of their principal.
Jensen and Meckling 1976

Agency Theory and Its implication on
corporate Governance
-A agency problem is asymmetrical access to information
-Directors know far more about the corporate situation than the shareholders
- shareholders have to rely on the directors to decide what information they should have, over
and above the minimum required by regulation and company law.
-Agency theory takes a view on the nature of man:

1.that people are self-interested not altruistic
2.that directors will act in their own interests not the best interests of their shareholders
3.essentially that people cannot be trusted
Effect of Agency Theory/Contract of
Agency
- Simple Agency contracts
- Whenever the owner of wealth (the principal) contracts with someone else (the agent) to manage
his affairs the agency dilemma arises
-In a limited-liability company there may be many principals (shareholders) and their agents
(directors)
-Shareholders interests are seldom homogeneous
- Effect of growing listed companies

Effect of Agency Theory/Contract of
Agency
- Strings of agency relations in Public companies
- An individual owner might invest his funds through a financial

adviser
- tracing the agency chain in such cases can be difficult
- Effect of growing listed companies

Solution to Agency Problem
- Demands for reporting and transparency
- Requirements for accountability and audit
- Independent directors
- Separation of chairman and CEO
- Other regulations and legal requirements
- Corporate governance codes and principles

Agency Problem at other companies
- not limited to relations between shareholders in listed

companies and their directors
- In private companies also
- Due to separation of members and the governing bodies
- What constitutes the governing bodies?
- Agency dilemma when there is delegation of

responsibility
Corporate Governance Code (India)
• Is an association of Indian businesses
• Non-government, not-for-profit, industry-led and
industry-managed organization, playing a proactive
role in India's development process
• CII works closely with Government on policy issues
- It has 64 offices, including 9 Centers of Excellence, in
India, and 7 overseas offices
• Numerical data about CII
https://www.cii.in/membership_profile.aspx?enc=PuO5
CCh0+R5Vy5wBSXovVw
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• In 1996,CII took a special initiative on Corporate
Governance – the first institutional initiative in Indian
industry
CII Roles
• Their primary goal is to develop Indian industry and to
ensure that government and society as a whole,
understand both the needs of industry and its
contribution to the nation's well being.
For this, it works

• To identify and strengthen industry's role in the
economic development of the country
• To act as a catalyst in bringing about the growth and

development of Indian Industry
-
CII Roles
• To provide up-to-date information and data to industry and
government
• To identify and strengthen industry's role in the economic

development of the country
• To reinforce industry's commitment to society
• To create awareness and support industry's efforts on

quality, environment, energy management, and consumer
protection
CII Roles
• To identify and address the special needs of the small
sector to make it more competitive
• To promote cooperation with counterpart

organizations
• To work towards the globalization of Indian industry

and integration into the world economy
CII Recommendations
Recommendation 1
There is no need to adopt the German system of two-tier boards to
ensure desirable corporate governance. A single board, if it performs well,
can maximise long term shareholder value just as well as a two- or multi-
tiered board. Equally, there is nothing to suggest that a two-tier board,
per se, is the panacea to all
corporate problems.
Recommendation 2
Any listed companies with a turnover of Rs.100 crores and above should
have professionally competent, independent, nonexecutive directors, who
should constitute
• at least 30 percent of the board if the Chairman of the company is a
non-executive director, or
• at least 50 percent of the board if the Chairman and Managing Director
is the same person.
CII Recommendations
Recommendation 3
No single person should hold directorships in more than 10 listed
companies.
Recommendation 4
For non-executive directors to play a material role in corporate
decision making and maximizing long term shareholder value, they
need to
• become active participants in boards, not passive advisors;
• have clearly defined responsibilities within the board such as
the Audit Committee; and
• know how to read a balance sheet, profit and loss account,
cash flow statements and financial ratios and have some
knowledge of various company laws.
CII Recommendations
Recommendation 5
To secure better effort from non-executive directors, companies
should:
• Pay a commission over and above the sitting fees for the use
of the professional inputs.
• Consider offering stock options, so as to relate rewards to
performance.
Recommendation 6
While re-appointing members of the board, companies should
give the attendance record of the concerned directors. If a
director has not been present (absent with or without leave) for
50 percent or more meetings, then this should be explicitly
stated in the resolution that is put to vote. As a general practice,
one should not re-appoint any director who has not had the
time attend even one half of the meetings.
CII Recommendations
Recommendation 7
Key information that must be reported to, and placed before,
the board must contain:
• Annual operating plans and budgets
• Quarterly results for the company as a whole and its
operating divisions or business segments.
• Internal audit reports
• Default in payment of interest or non-payment of the
principal on any public deposit, creditor or fI’s.
• Any issue which involves possible public or product liability
claims of a substantial nature
• Details of any joint venture or collaboration agreement.
• Transactions that involve substantial payment towards
goodwill, brand equity, or intellectual property
CII Recommendations
Recommendation 8
1. Listed companies with either a turnover of over Rs.100 crores
or a paid-up capital of Rs.20 crores should set up Audit
Committees within two years.
2. Audit Committees should consist of at least three members,
all drawn from a company’s non-executive directors
3. To be effective, the Audit Committees should have clearly
defined Terms of Reference and its members must be willing to
spend more time on the company’s work
4. Audit Committees should assist the board in functions
relating to financial statements and proposals that accompany
the public issue of any security
5. Audit Committees should periodically interact with the
statutory auditors and the internal auditors to ascertain the
quality of the company’s accounts as well as the capability of
the auditors themselves.
CII Recommendations
Recommendation 9
Under “Additional Shareholder’s Information”, listed
companies should give data.
Recommendation 10
1. Consolidation of Group Accounts should be optional and
subjective
2. If a company chooses to voluntarily consolidate, it should
not
be necessary to represent the accounts of its subsidiary
companies under section 212 of the Companies Act.
CII Recommendations
Recommendation 11
Major Indian stock exchanges should gradually insist upon a
compliance certificate, signed by the CEO and the CFO, which
clearly states that:
• The management is responsible for the preparation, integrity
and fair presentation of the financial statements and other
information in the Annual Report
Recommendation 12
For all companies with paid-up capital of Rs. 20 crores or
more, the quality and quantity of disclosure should be clearly
defined.
Recommendation 13
Government must allow far greater funding to the corporate
sector against the security of shares.
CII Recommendations
Recommendation 14
1. If any company goes to more than one credit rating agency,
then it must divulge in the prospectus and issue document the
rating of all the agencies that did such an exercise.
2. It is not enough to state the ratings. These must be given in a
tabular format that shows where the company stands relative to
higher and lower ranking. It makes considerable difference to an
investor to know whether the rating agency or agencies placed
the company in the top slots, or in the middle, or in the bottom.
Recommendation 15
Companies that default on fixed deposits should not be
permitted to
• accept further deposits and make inter-corporate loans or
investments until the default is made good; and
• declare dividends until the default is made good

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Agency Theory and Its implication on

- A contract under which one or more persons (shareholders) engage another

- If both parties are utility maximizers… agents will

Jensen and Meckling 1976

-A agency problem is asymmetrical access to information

-Agency theory takes a view on the nature of man:

- Simple Agency contracts

-Shareholders interests are seldom homogeneous

- Effect of growing listed companies

- Strings of agency relations in Public companies

- An individual owner might invest his funds through a financial

- tracing the agency chain in such cases can be difficult

- Effect of growing listed companies

- Demands for reporting and transparency

- Requirements for accountability and audit

- Separation of chairman and CEO

- Other regulations and legal requirements

- Corporate governance codes and principles

- not limited to relations between shareholders in listed

- In private companies also

- Due to separation of members and the governing bodies

- What constitutes the governing bodies?

- Agency dilemma when there is delegation of

For this, it works

• To act as a catalyst in bringing about the growth and

• To identify and strengthen industry's role in the economic

• To reinforce industry's commitment to society

• To create awareness and support industry's efforts on

• To promote cooperation with counterpart

• To work towards the globalization of Indian industry

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