Principals-Agents’ Conflict of Interest

Principals (sh atomic number 18holders) divisor (managers) problem represents the fighting of interest mingled with management and owners. For example, if shargonholders cannot effectively monitor the managers behaviour, consequently managers whitethorn be tempted to use the firms assets for their own ends, all at the expenses of shargonholders. Discuss the pros and cons of this statement with regard to duties of Board of Directors. Most organisations these days are no more owned by their managers. This separation of ownership and management gives rise to what is called agency relationship.Jensen and Meckling (1976) define the agency relationship as a urge on under which virtuoso party (the principal) engages another party (agent) to perform the or so services on their behalf. As part of this, the principal leave behind delegate some decision making authority to the agent . However, it is important to mention that this relationship is not always peaceful and harmonious rather , it usually raises some agency problems unremarkably called conflict of interests between shareholders and managers of the company.These conflicts occur when a person i. . the manager has an obligation not to execute in his own personal interest but in another persons interest i. e. the shareholders. This means that in whatever situation, managers must prioritise shareholders benefits. But is this commitment always respected in principals-agents relationships? Hopefully, between these two groups, is the board of directors directors who are elected by shareholders to act as their representatives by monitoring and lordly managers tasks and ensuring they are in patronage with shareholders expectations.With clear test that conflicts of interest are almost unavoidable in any agency relationships, an attempt will be made will be made to consider an insight into that issue with regards to board of directors duties. Brennan (1994) states that agency problems emanate from the arrange ment where the interests of the agents differ substantially from those of the principals because of the impossibility of perfectly contracting for every possible action of the agents whose decisions put on both his welfare and the welfare of the principal .Therefore, this raises the issue of finding ways to motivate managers to solely act in the stovepipe interest of shareholders. However, in a world where the labour market is becoming more and more imperfect and competitive, managers will be more concerned with their personal benefits at the expense of shareholders benefits. Since they are the one taking care of the day-to-day activities of the company, they know better than anyone any single details ab break how the various tasks are being performed and how that affects the company.Therefore, they might be tempted to ingest advantage of that by consuming some of the organisations resources in the form of lavish perquisites such as airplanes. Agency conflicts imply that sharehol ders wealthiness maximisation is being subordinated in managers goals for the company. Clear evidence of this assumption could be that top level managers are more worried about increasing their salaries, reproduction their status within the company, creating more opportunities for lower managers or assuring their job security and to achieve all this, their main objective could rather be to have a fit the firm by creating more subsidiaries.Such an action could produce results that do not necessarily maximise the value of the organisation for shareholders, rather, management welfare. We can pock that in conflict of interest, agents are mostly interested in achieving objectives that they feel will be profitable to them, but which are not necessarily or directly for the sake of shareholders.This occurs as a result of the distance created between the shareholders and the management team which prevent the former to effectively monitor and control managers behaviour. If agents do thing s that hurt principals, why dont they take strong actions against that? In order to remedy to this situation, shareholders rely among others on the board of directors which they elect to look out for their interests and protect them for financial losses due to inadequate managerial actions.Bonazzi L. , Islam (2007) defines the function of the board as a collective responsibility to determine the companys aspire and ethics, to decide the direction, i. e. the strategy to plan to monitor and control managers and CEO activities, then to report and make recommendations to shareholders . To achieve this, they are expected to act in accordance with their four main duties which involve the fiduciary duty, the duty of loyalty, the duty of confidentiality and the duty of care.In performing their fiduciary duties, directors assumes two roles, the first one as an agent which means acting on behalf of shareholders and the second one as a trustee which means they are in charge of controlling th e organisation assets so they have to act bona fide which means in good faith towards the company acting only within the scope of their powers and uniquely for the purpose that benefits the business and to avoid being involved in conflict between personal and the companys interest.First and foremost, the board has as duty to range the organisation by designing broad policies, and objectives which are intended to provide managers with guidance on how they are expected to run the business, i. e. prioritizing principals benefits, and, where they are expected to take the firm to in terms of increasing its value. They must continuously review the performance of the chief executive to ensure that managerial actions are in line with shareholders wishes and given that they are accountable to the former, they have to report to them about the overall organisational performance.Regarding their duty of loyalty, directors must prevent conflict of interest by avoiding transactions which may ge nerate a potential conflict those transactions according to Professor Bernard S. Black of Standford Law School in an article entitled The principal fiduciary Duties of Boards of Directors are called self-dealing transactions.Representing at the same time the boss to one extend and the subordinate to another extend, directors must make sure never to act in ways that will harm either the shareholders or the executives, treat both parties with care and respect and try to make good decisions i. . that will compromise none of the parties, but which will be profitable to the firm. Also, board members have the duty to keep private all dealings, matters and information from the board meeting and the company in order to avoid the disclosure or misuse of information which may channelise to a conflict. From the study of board members duties, we can state that companies corporate establishment rests mostly on their shoulders.So, when effective, it permits the realisation of corporate objec tives, risk management, the reduction of agency problems and an increase in the value of the firm. Despite the fact that conflict of interest is kind of an obvious issue between shareholders and managers, it is important to keep in mind that the former are the owners of the business and thus, have great powers on the company for exemplar through their voting rights at the annual shareholders meeting where they might decide to vote with their feet i. . selling their shares, exposing the organisation to a potential takeover that will lead managers to lose their job. Consequently, managers must at least try to satisfy their principals by aligning their actions and decisions with shareholders expectations as well as must principals induce their agents to work for their crush interest. To achieve this, they must incur some agency be.In the 1976 Journal of Finance paper by Michael Jensen and William Meckling, it is stated that there are three major types of agency costs (1) expenditu res to monitor managerial activities, such as audit costs (2) expenditure to structure the organisation in a way that will limit undesirable managerial behaviour, such as appointing outside members to the board of directors or restructuring the companys business units and management hierarchy and (3) opportunity costs which are incurred when shareholder-imposed restrictions, such as requirements for shareholder votes on specific issues, limit the ability of managers to take actions that advance shareholder wealth.In a nutshell, conflict of interest is a real fact in every business. Principal-agent relationship can be viewed as complex in terms of how exactly agents are expected to act towards their principals. Obviously, their acts must always be aimed at serving shareholders interest, but this statement seems to imply that either principals interests are always morally bankable or managers might act unethically provided they fulfil shareholders expectations.Virtually, all corporat e code of ethics addresses conflict of interest because it interferes with the ability of employees to act in the best interest of the firm. The fact is that, the agent is expected to act solely for the benefit of the principal in all matters and situations, yet, the kind of situation or dilemma the agent might be called upon to act in his principal interest are not easily predictable or identified. As optimal solution, it would be good for both parties if they could work in concert prioritising the success of the organisation, and trying to satisfy as much as possible each groups benefits, because it would assistance avoiding or at least reducing potential conflict of interest.