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Home > Business Ethics Checklists > Conflicting Interests: The Agency Issue

Business Ethics Checklists

Conflicting Interests: The Agency Issue


Checklist Description

This checklist examines possible conflicts of interest, which create the risk that a company is run in a way that does not deliver maximum value for stockholders, due to management’s self-interest or pressure from dominant external stockholders.

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Definition

Those running a company should be committed to delivering maximum returns to its stockholders. However, vested interests can sometimes play a role in decision making, frequently managers’ personal interests. The way in which a company’s stock is dispersed across various stockholder groups can also have a significant bearing on the nature of the specific corporate governance issues it faces. In many developing countries, as well as in some parts of Europe, company stock ownership can be concentrated within a relatively narrow group of investors—certainly when compared with the wider stock-ownership base that is typical in the United States. This concentration of ownership can heighten the risk that the company board is pressurized to make a particular decision—for example, by a powerful industrialist or oligarch with widespread interests and considerable influence, who attempts to steer a company’s board down a particular route, potentially to the detriment of other stockholders.

Even in countries where stockholder bases are generally more diversified, conflicts of interest can still arise between company principals and boards of directors in cases where those making decisions are influenced by self-interest. Managers should in all cases inform the board of any potential conflict of interest between themselves and stockholders in advance. Stakeholders can then be made aware of the potential conflict of interest through a disclosure statement, while the board should take appropriate action to ensure that the interests of stockholders are not compromised. This could involve independent monitoring of management decision making or the insistence that the relationship behind the potential conflict of interest is severed.

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Advantages

  • Correctly anticipating potential conflicts of interest gives corporate governance professionals the scope to instigate procedures that will ensure probity and help to protect stockholders.

  • A well-diversified stockholder base and thorough research by investment analysts into a company’s decision making can help to remind managers that any actions they take to put their own interests ahead of the wider stockholder base could be exposed, making them vulnerable to removal from their positions.

  • Companies seen to be operating in an inappropriate manner can rapidly lose stockholder support, exposing them to the risk of a hostile takeover. This risk can create an element of “self-policing” by managers who would otherwise be tempted to put their own interests ahead of those of the wider stockholder base.

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Disadvantages

  • Aiming for complete protection against the impact of the agency issue is unrealistic. Steps can be taken to try to address the main risks, but in practice major stockholders may still hold considerable influence.

  • Striking the balance between rewarding top-performing managers and allowing them excessive influence over their own remuneration levels can be difficult.

  • Operating an effective and robust corporate governance program can be expensive, with the costs ultimately carried by the stockholders.

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Action Checklist

  • The establishment of an independent remuneration committee is often an important step toward adequately rewarding top-performing executives and satisfying large institutional stockholders that the company’s resources are being used appropriately.

  • Aim to align executive compensation with stockholders’ interests by granting managers stock options.

  • Other elements of executive compensation can be linked to factors such as sales or earnings growth.

  • The establishment of a management monitoring program can help to counter the risk of pressure from dominant external stockholders and protect the interests of other stockholders by scrutinizing executives’ decisions.

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Dos and Don’ts

Do

  • Ensure that executive remuneration is set by an independent committee with an understanding of competitors’ compensation levels.

  • Be prepared to permit the remuneration committee to grant stock options to managers to incentivize them to deliver maximum returns for stockholders.

Don’t

  • Don’t see scrutiny by external investment analysts as a threat: the greater threat to a company’s stock price could come from suspicions that managers are feathering their own nests, rather than working to deliver maximum stockholder value.

  • Don’t skimp unnecessarily on the costs of establishing appropriate structures to oversee executive remuneration and decision making. Disquiet over the probity of decision making can trigger a loss of confidence among key institutional stockholders. In terms of executive remuneration, excessive levels could trigger a stockholder revolt, while companies that under-remunerate executives risk the upheaval of losing key talent to rivals.

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Further reading

Books:

  • Sullivan, John D., Jean Rogers, Catherine Kuchta-Helbling, and Aleksandr Shkolnikov (eds). In Search of Good Directors: A Guide to Building Corporate Governance in the 21st Century. 3rd ed. Washington, DC: Center for International Private Enterprise, 2003.
  • Luo, Yadong. Global Dimensions of Corporate Governance. Malden, MA: Blackwell Publishing, 2007.
  • Organisation for Economic Co-operation and Development (OECD). OECD Principles of Corporate Governance. Paris: OECD, 2004. Online at: www.oecd.org/daf/corporateaffairs/principles/text

Website:

  • International Corporate Governance Network (ICGN): www.icgn.org

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