Corporate Governance

Abstract

Agency relationship is a contract, under which one party (the principal) delegates some decision-making authority to another party (the agent). Agency conflict arises because of the separation of ownership and control. The self opportunistic behavior of agent (management) is also responsible for agency conflicts. As there is misalignment of interest between principal (owner) and agent (management), the principal (owner) needs to induce the agent (management) to act in the best interests of the principal. Thus the principal has to bear the cost of monitoring and bonding the activities of the management. Some effective control mechanisms can be used to align managers and shareholders’ interests. The interest of owners and management can be aligned with the help some effective corporate governance mechanisms like powerful Board of Directors, independent non-executive directors, corporate debt capital, managerial incentive schemes linking the incentive to the performance of the company, managerial ownership and presence of institutional shareholders. Independent non-executive directors can perform the function of check and balance which can discipline the opportunistic behavior of management. Managerial ownership can develop the sense of belonging among the management. This can induce the management to become long term oriented and make value increasing decisions. Debt financing can solve the problem of free cash flow problem and limit the managerial discretion at spending the free cash flow. Institutional shareholders can raise voice against the opportunistic behavior of management. Other mechanisms may include voluntary disclosure and market for managerial talent. Agency costs can mitigated to a great extent by utilizing these corporate governance mechanisms appropriately.

Introduction

Because of agency conflict, it is essential to find ways so that the interest of the shareholders and management can be aligned. In the absence of proper control...