Limitations Of Agency Theory Finance Essay

Limitations Of post Theory Finance EssayIrrespective of the new well-deserved critical review of Agency Theory I reckon it should still play an signifi bay windowt role in managerial remuneration. empiric licence supports the opening that a conflict of interest exists ming take with stockholders and focal point.Through place recent years iodin of the much commonly discussed management topics has been administrator earnings and in finicky the size of bonuses awarded to CEOs and a nonher(prenominal) ripened management.Agency speculation can be con nervered to be the nigh widely used opening to explain decision maker compensation. The nidus of Agency guess is on rooms to make the political science system of corporations more effective so that sh atomic number 18holders interests and performance expectations argon condition eery chance to be realised by the Chief executive director Officer (CEO).An authorisation problem may arise amid managers and sharehold ers because the principals (the shareholders) cannot adequately monitor the actions taken by the agent (the managers). Subsequently, the agent can pee an incentive to pursue their own interests, rather than the bet interests of the principal.Given the trunk of evidence, it would be nave to cl pay off that position surmisal has not do a significant contribution to the principal-agent literature. However it does fool its limitations and a newfangled approach is needed to use the benefits of means supposition to its fullest.By realizing mental representation theorys limitations, we can provide to its strength. Droege, Scott BA key issue veneer situation theory is the reliance that stakeholders have on the poster of directors. This has prove to be an unhealthy reliance and the level of independance of well-nigh board of direcors can be questioned. This is discussed by Band (xxxx) when he state that while in that respect is a common perception that the board is in paras itic, this is lots fake as noted by Pearce and Zahra who found that everyplace 85% of Fortune calciferol industrial companies had Chairmen who had also served as the corporations CEO.It is well documented that executive compensation packages should be designed to align the interests of senior management with those of the shareholders and thereby decoct the dysfunctional behaviour of managers this is typic all toldy done by honor executives for winning decisions and actions that summation shareholder wealthiness (26 Mortlock, 2009). Unfortunately, the shareholders (and directors) may have uncomplete free information about the actions of executives or the expertise to evaluate those actions, fashioning it intemperate to base compensation on actions alone. Instead, compensation in usage is often linked to measures that are positively correlated with managerial performance, for exemplify foodstuff share, share harm or bill profit.Additionally In recent years Boards have give out weaker as more effect has been distributed to senior management. This has resulted in the win instantly out of the answerableness of Directors and a resulting impingement in the decline of the monitoring role of Boards. bodily Governance David BandThe board of directors is hard reliant on the information provided by the CEO.The recent spate of failures among 2 monetary and non- financial companies has been accompanied by a growing interest in and concern about the compensation of the CEOs of major(ip) U.S. corporations. This, in turn, has reignited interest among both(prenominal) academics and financial practitioners about position theory issues, especially the question of whether or not the total compensation of CEOs is flop scaled in congener to the earnings they generate for the shareholders they serve.We find that the executive remuneration design derived from a single agency perspective is insufficient. horizon theory, real option theory and managerial p ower approach all together would complement agency theory to induce the theory of executive remuneration closer to earthly concernAdam Notes Agency Theory or Stewardship theoryLimitations of Agency theory Irrespective of the recent well-deserved criticism of Agency Theory I believe it should still play an important role in managerial remuneration. Empirical evidence supports the theory that a conflict of interest exists between shareholders and management.The board still functions on information provided by the CEO.While there is a common perception that the board is independent, this is often fake as noted by Pearce and Zahra who found that over 85% of Fortune 500 industrial companies had Chairmen who had also served as the corporations CEO.In recent years Boards have croak weaker as more power has been distributed to senior management. This has resulted in the decline of the accountability of Directors and a resulting impact in the decline of the monitoring role of Boards.Corp orate Governance David BandThe appropriate remedy for the problem of the potentially self- kindle or incompetent managerial team is said to be the monitoring board. only if frankly, no one really knows what is the optimal level of option agree what level of extend option compensation get out make an executive luck-neutral like the shareholders, or willing to bite the bullet on layoffs, or willing to accept a premium bid? Even if the phone line price falls back, the well-timed executive option exercise is a life-changing experience. More formally, the B lack-Scholes option pricing gravel instructs us that the cherish of the executives stock option will be change magnitude both in the value of the underlying security and the variance (since stock options are issued at the money). So managers with a rich load of options have incentives to get the stock price high by any means necessary, machination included. In particular, they have incentives to increase the riskiness of the firm, including projects that offer lower expected returns but high variance. This will bowdlerize the value of the firm for risk-neutral shareholders but has the potential to increase the value of managers firm-related investments in fictional characters where the gain in option holdings exceeds the loss to adult male capital. Managers be fuck off risk-preferring. Enron Jeffrey GordonProspect theory, real option theory and the managerial power approach all together would complement agency theory to bring the theory of executive remuneration closer to reality. On the opposite hand, theoretically, beingness the main stream theory of corporate governing body, agency theory suggests rough-and-ready executive remuneration should align managers interests with shareholders interests in order to minimize agency costs (Florackis, 2005 Bayless,2009). close remuneration frameworks in the literature have been for the intimately part solved by agency theory. However, notable diver gences exist between thepredictions of agency theory and reality. There is a need to extend agency theory with some complementary theories to make executive compensation more realistic.We find that the executive remuneration design derived from a single agency perspective is insufficient. Prospect theory, real option theory and managerial power approach all together would complement agency theory to bring the theory of executive remuneration closer to reality.Che, Zhang,Xiao and LiEmpirical support for agency theory has been designated in numerous settings. For example, Eisenhardts (1988) studies of retail stores show support for agency theory in salaried and commissioned salespeople. Acquisitions and divestitures were the boil down of a body of work by Argawal and Mandelker ( 1 987). Conlon and Parks ( 1 990) leavend performance-contingent compensation as the dependent variable and found support for agency theory. Support has been found in interorganizational joint ventures (Ba lakrishnanandKoza, 1993) and franchising (e.g., Agrawal and LaI, 1995). Although not an exhaustive review, this brief list gives adequate evidence that agency theory has been empirically tested and supported in a variety of contexts from retail sales to manufacturing to joint ventures. Given this body of evidence, it would be nave to claim that agency theory has not made a contribution to the principal-agent literature. Indeed, it has made a significant contribution. Thus, it is not my intent to depress agency theory. However, a rational course is to separate the premises and examine them in a new light.By realizing agency theorys limitations, we can add to its strength. Droege, Scott BAgency theory can be con alignred to be the most widely used theory to explain executive1 compensation. Agency theory, from stintings, focuses on ways to make the governance system of a corporation more efficient so that shareholders interests and performance expectations are realized by the Chief e xecutive director Officer (CEO).The failure to find a concordant link between executive compensation and a firms performance has motivated some authors to addendum agency theory with other theories originating in psychology and sociology (e.g., Ungson and Steers, 1984 Wiseman and Gomez-Mejia, 1998 Bainbridge, 2005 Gomez- Mejia et al., 2005 and Perkins, 2008).It should be explicitly mentioned here that it is not our mark to replace agency theory with other theories. Rather, we recommend adding other theoretical lenses, originating in other paradigms, to make our reason of executive compensation more complete.While discussing severally of the theories, it will become clear that rather than taking a single theory perspective, it is desirable to take a multi-theory approach to explain the complicatedities of executive compensation. This is also a logical consequence of the use of three paradigms. downstairs such an approach, antithetical paradigms and theories together serve to explain executive compensation better and more completely than opting for a single theory or paradigm.Over the closing decades, hundreds of studies have been published in the field of executive compensation. Agency theory was found to be the dominant framework. This theory puts forward the relationship between firm performance and executive compensation as one of the mechanisms to reduce agency costs. The inability to find a consistent relationship between performance and executive compensation, however, has disposed rise to the development of alternative theories. The most popular alternative theories include managerialism theory, institutional theory and contingence theory. stiff support was found for taking such a multi-theoretical and multi-disciplinary view of executive compensation. The control perspective (agency theory), which has historically been the main perspective, has to be enriched with behavioral, institutional and contingency factors.Baeten, Xavier Balkin, David In the aftermath of the global financial crisis (GFC) governments lost confidence in mart fundamentalism and realised the inadequacies of regulatory measures. The purpose of this paper is to outline the proximate causes of the financial crisis of 2007-2009 and to investigate the role of the shareholder wealth maximization (SWM) objective in the GFC. The case studies revealed that unethical behaviour, agency issues, CEO compensation, creative invoice and risk shifting are some of the side effects of SWM. These cases debate that the assumptions on which SWM are based are questionable. Further, it can be argued that the al-Qaida cause of the GFC is excessive greed and the single-minded pursuit of SWM.The global financial crisis (GFC), which had been threatening for some time, began to display its effects in the middle of 2007 and into 2008. most the world, stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthie st nations have had to develop with rescue packages to bail out their financial systems.Had all boards of directors being successful in their assigned role of defend all stakeholders of the firm, rather than just shareholders, then we believe that the GFC would have been avoided.Most business concern is focused on profit maximization. However, profit maximisation fails for a number of well-known reasons it ignores the timing of returns the cash flows available to shareholders and risk.Without explicitly considering these factors, higher earnings alone do not necessarily turn in into higher share prices.Damodaran (1999) explains that, in the real world, managers perform the decision-making function with foursome factors or linkages in mind shareholders, bondholders, familiarity and financial markets. Competitive market conditions place significant pressure on agents and managers who will be tempted to stamping ground to unethical means to portray a positive picture. It is ackno wledged that the wealth maximisation objective is not always compatible with a firms neighborly obligations, and it normally involves an agency problem which arises when the managers fail to act in the ruff interests of the shareholders, preferring instead to benefit themselves (20 Jensen and Meckling, 1976).Differences in the objectives of ownership and management lead to agency costs if these are to be controlled, the shareholders must keep back a relentless watch over the functioning of the company. The managers should be rewarded for acting in the interests of the shareholders and the managers should maintain a balance between the interests of the shareholders and other stakeholders. In this context, the GFC highlighted the important influence that incentive structures within financial institutions and other businesses can have on risk-taking and financial performance. In particular, it highlighted the dangers of badly designed remuneration incentive arrangements leash to e xcessive risk-taking, poor financial performance and a bias towards short results at the expense of longer-term financial soundness (26 Mortlock, 2009).It is well documented that executive compensation packages should be designed to align the interests of senior management with those of the shareholders and thereby reduce the dysfunctional behaviour of managers this is typically done by rewarding executives for taking decisions and actions that increase shareholder wealth (26 Mortlock, 2009). Unfortunately, the shareholders (and directors) may have neither complete information about the actions of executives or the expertise to evaluate those actions, making it difficult to base compensation on actions alone. Instead, compensation in practice is often linked to measures that are positively correlated with managerial performance, for instance market share, share price or accounting profit.Stock options became an ever greater part of executives compensation, increasing from 27 per ce nt in 1992 to 60 per cent in 2000. Fixed salary will reduce the risk to the executives and guarantee a standard of living. On the other hand, it may not encourage them to improve their performance in order to maximise shareholder wealth. The use of golden handshake and golden parachute clauses in management contracts may also be driven by managers acting to boost their own interests, rather than those of their shareholders.25 Matsumura and Shin (2005) characterized conflicts of interest between shareholders and managers as usually arising in three broad areas. First, executives enjoy (as well as exploit) the perquisites provided to them. Second, executives are more risk averse in decision making and aim for better compensation as a trade-off. Lastly, executives are more interested in making decisions that have short-term impacts rather than taking a long-term perspective. By designing executive packages in a way that balances the interests of shareholders and executives, these conf licts can be reduced. The packages should be so designed to motivate the executives, whilst at the same time allowing management to control the amount spent on compensation, based on the performance of the CEOs themselves. 26 Mortlock (2009) notes that the major financial and corporate sphere of influence distress seen in the USA and Europe in recent times is partly attributable to poorly designed remuneration incentive arrangements.An trial run of history reveals that a range of practices, unrelated to any major return in cash flows and/or profits, have been carried out with the intention of increasing wealth for example accounting manoeuvres with deceitful intention and accounting fraud (in the case of Xerox), improper accounting, deviation from accounting principles with deceitful intention, leveraging of shares to deepen debt for expensive acquisitions (as in the case of WorldCom), stretching the limits of accounting by misusing its limitations, lack of transparency, intent ional projection of a rosy picture of performance (in the cases of Enron and Arthur Anderson), long fraud, accounting scandal (in the case of Peregrine Systems), aggressive acquisition strategies and accounting frauds (in the case of Tyco), diverting business cash into off-shore, family-owned entities, artificial support given to the stock of the company (in the case of Polly Peck), deceitful intention of elite and experienced hands with sophisticated outlets (in the case of BCCI banks) and highly leveraged synthetic financial instruments (in the case of Goldman Sachs).Creative accounting is the manipulation of financial numbers, usually within the letter of the law and accounting standards, although its use can be unethical and does not provide the true and fair view of a company that accounts are supposed to provide (45 Moneyterms, 2009).Common to all the cases mentioned above was managements single-minded focus on SWM. By attempting to grow the company at high race and by using creative accounting techniques, managers had failed to foresee the detrimental actuate these actions would have in the long term.It is clear that, in light of the side effects of SWM as discussed in Section 4 particularly their impact during the crisis the validity of the above assumptions has become questionable. In this regard, 19 Jenkins and Guerrera (2010) argue that the recent randomness attack on Goldman Sachs strikes at the heart of the business model, a model that, as 46 Friedman (1970) states, views the social responsibility of business being to increase its profits. However, as an agent, a manager is bound to act to maximise the wealth of shareholders, rather than to follow an agenda of social responsibility.It is clear that major issues like unethical behaviour, executive compensation, creative accounting and conflicts of interest, pushed the big entities towards major difficulties and, in many another(prenominal) cases, collapse. Though a series of accounting regul ations were designed and directed, many monstrosity organisations found convenient loopholes to take advantage of or, if this was not possible, resorted to manipulative means, actions which lastly contributed substantively to the financial crisis.Hull (2009) argues that the inappropriateness of extant incentive schemes led to a short-term focus in the managerial decision making. Given this situation, in February 2009, US President Barack Obama introduced new restrictions on executive compensation for institutions that hear financial assistance from the government, by limiting cash compensation to US$500,000 similarly, the USs Financial Stability Board released a set of principles aimed to ensuring effective governance of compensation and the effective alignment of compensation with prudent risk taking. These developments in turn suggest that the SWM objective is neither self-regulatory nor flawless in nature.As we have discussed in this paper, the reasons for the burst of this fin ancial bubble are many. However, most of the factors are (directly or indirectly) linked to the pursuit of SWM. The above discussion has shown that each factor had in common the desire to increase the value of owners wealth. It appears fair(a) to argue that, by forgetting the importance of ethics and deviating from accounting principles, the greed pay off.Risk shifting and dysfunctional behaviour are some of the side effects and flaws in an SWM-based system that is not self-regulatory.Because of a strong focus on profit maximisation or even SWM, the corporate decisions that led to the economic downturn were never balanced with any good citizen approach. entirely value maximisation alone is no longer sufficient in todays competitive global business environment organisations need to focus on objectives that have long-term benefits rather than short-term value. By taking stakeholders and society into consideration a firm will truly begin to give sustainable wealth while the corpora te objective function is dominated by SWM this cannot take place. Yahanpath, NoelSupporters of agency theory underscore, among its positive features, the realism with which it describes relationships among somebodys in a company(Eisenhardt, 1989). The firm is no longer considered as a single, monolithic actor but the complex set of interactions among several one-on-ones. The firm is now presented as a nexus of contracts between principals and agents (Maitland, 1994 Shankman,1999).Typically, there are polar goals and interests among individuals involved in an agency relationship. Agency theory presupposes that individuals are opportunistic, that is, they incessantly aim to maximize their own interests (Bohren, 1998). Thus, there is no guarantee that agents will always act in the best interests of principals. Rather, there is a ageless temptation for agents to maximize their own interests, even at the expense of principals.Under conditions of incomplete information and uncertaint y prevalent in business settings two kinds of problems arise adverse endurance and incorrupt hazard (Eisenhardt, 1989, p. 58). Adverse selection refers to the possibility of agents misrepresenting their ability to do the work agreed in other words, agents may adopt decisions inconsistent with the contractual goals that embody their principals preferences. Moral hazard, on the other hand, refers to the danger of agents not putting forth their best efforts or shirking from their tasks.This divergence between the interests of the principal and the agent unavoidably generates costs. Agency costs are residual costs that result in a failure to maximize the principal_s wealth. These may be incurred by the principal with measures to control the agent_s behaviour or by the agent through efforts to demonstrate his commitment to the principal_s goals.The whole point behind agency theory is to come up with mechanisms that ensure an efficient alignment of interests between agent and princi pal, thereby reducing agency costs (Shankman, 1999, p.321).Principals are thus challenged to design contracts that value their interests and maximize their utility in case of conflict. These contracts are based on several assumptions regarding agents (self-interest, limited rationality, risk aversion), organizations (goal conflict between members) and information (asymmetrical) (Shankman, 1999, p. 332).Supporters of agency theory underscore, among itspositive features, the realism with which it describes relationships among individuals in a company (Eisenhardt, 1989). The firm is no longer considered as a single, monolithic actor but the complex set of interactions among several individuals.Methodologically, agency theory subscribes to individualism its basic building block of analysis is the human being fully constituted as an individual and bereft of any social dimension. In every endeavour individual agents seek above all their own utility (utilitarianism) or recreation (hedon ism), the satisfaction of their own desires. They form groups not to fulfil any indispensability of their proper flourishing as human beings but only to advertize their particular interests (contractualism).Outside of this, agents do not subscribe to any moral imperative they willingly engage in immoral conduct whenever convenient. playing morally would be reasonable only if it presented a greater economic incentive in terms of utility and pleasure than the contrary (Bohren, 1998).Joan Fontrodona, Alejo Jose G. genus SisonThe recent spate of failures among both financial and non-financial companies has been accompanied by a growing interest in and concern about the compensation of the CEOs of major U.S. corporations. This, in turn, has reignited interest among both academics and financial practitioners about agency theory issues, especially the question of whether or not the total compensation of CEOs is properly scaled in relation to the earnings they generate for the shareholde rs they serve.Our null hypothesis, consistent with the popular assumption in the media, is that the secular growth of CEO compensation has become increasingly misaligned with the earnings results that CEOs have produced for shareholders. Surprisingly, our initial findings, drawing on secular trends among SP 500 firms, appear to show that our hypothesis does not hold, and that, over an extended period of time, CEOs have not received compensation that is out of line with the their companies earnings trends.Zhao, Kevin M Baum, Charles L Ford, William F2.0 Diagnosis of Problems and notional Analysis2.1 Organisational Change2.2 Conflict Cognitive Dissonance2.3 Communication2.4 lead3.0 Recommendations3.1 Organisational Change Management Recommendations3.2. Conflict Management Recommendations3.3. Communication Recommendations4.0. Conclusion