AGENCY ECONOMICS AND INTERNATIONAL COMPARISONS OF CORPORATE GOVERNANCE SYSTEMS

1. AGENCY ECONOMICS AND INTERNATIONAL COMPARISONS OF CORPORATE GOVERNANCE SYSTEMS

2. Organisational Economics Thereare two major branches of OE: • Agency theory regards the firm as a series of contractual relationships between owners and workers • Transaction costs theorists view the organisation as a series of transactions • Both perspectives address how owners try to ensure that employees, suppliers, and contractors conduct themselves in a way that will help the organisation achieve its goals and both discuss governance mechanisms that can assure economic efficiency and minimize problems and costs

3. 1- Agency Theory • Agency theory is concerned about the relationship between principals (owners) and agents (employees) • Assumes agents will act in opportunistic ways; therefore, appropriate contracts and monitoring necessary to reduce agency costs 2- Transaction Cost Economics How to maximize efficiency of transactions by determining the proper boundaries of the Org. What should be done internally versuswhat should be contracted for on the outside?

4. Basic Points of Agency Theory • Organisations: series of contractual relationships between agents and principals • Principals: owners (shareholders) of a firm • Agents: people hired by the owners to run the firm (managers and workers) • Agency Costs: costs associated with monitoring agent behavior and enforcing contracts • Goal: efficient arrangement (lowest agency costs) of agent-principal relationships.

5. Basic Points of Transaction Cost Perspective • Organisations: series of transactions, some within the Org, some across the Org’s boundaries • Transaction:exchange of goods and services among groups within the Org. or across organisational boundaries • Transaction Costs:explicit fees or costs associated with a transaction; implicit costs of monitoring and controlling a transaction • Goal: to determine the most efficient arrangement of transactions — whether transactions should take place inside the Org or across Orgal boundaries; seek lowest transaction costs.

6. Transaction Cost as Problem to Remedy Organisational economists use the term “cost” to refer to a wide range of problems that owners must remedy in order to create an organization that allows for wealth maximization Types of Transaction Costs • Bounded Rationality • Asset specificity • Opportunism • Small Numbers • Information Asymmetry

7. 1- Bounded Rationality Owners and managers unable to process all of the available information, and face uncertainty in transactions or contract relationships • Therefore, costs are incurred by the owner in gathering and processing information in order to reduce these costs Employees, suppliers, and contractors may be in a position to take advantage of the owner

8. 2- Opportunism • Moral hazard: workers will not supply the agreed-upon effort Principals and agents often have different goals and will seek their own self-interest Agents will not always fulfill their obligations because they prefer leisure to work and are subject to shirking Adverse selection: agents will misrepresent themselves

9. 3- Information Asymmetry • Costs are incurred in gathering additional information and using various governance mechanisms Information related to exchanges or transactions is not evenly distributed Agents have certain information about their own behaviour and shortcomings that is not available to the principal

10. 4- Asset Specificity • Investment decisions in specific assets have implications on how the organisation governs its relationship with employees and other firms Assets that are very specific and fixed can reduce the flexibility

11. 5- Small Numbers • The organisation can more easily be exploited by a trading partner An organisation with only a small number of potential trading partners (an oligopoly) has a problem

12. The Perrow Critique • The theory presents too dismal a view of human beings interactions • Agency theory focuses too much on the problems of agents’ behaviour, while ignoring that the principals often engage in opportunistic behaviour • * Charles Perrow; Emeritus Professor of Sociology; Yale. • Work goes beyond the idea of merely being a contract between owners and workers • Workers are motivated by a complex set of objectives and are capable of honest and charitable acts

13. CAPITALISM: alternative taxonomies - examples • Market capitalism (USA, UK, Hong Kong, New Zealand, Canada) • Corporate/institutional capitalism (Sweden, Germany, Austria, Italy,Korea) • State-guided capitalism (Japan, France, Iran, Hungary) • “Crony”capitalism (Russia, Ukraine, Thailand, Indonesia)

14. Practice of Governance: UK • Most shares are held by pension funds, investment funds, and private individuals • Banks usually do not own shares • Almost all big companies are “listed” • Stock market performance of shares important measure of corporate success • “Hostile” takeovers fairly common

15. UK: Governance Assessment • Advantages: • Fairly open and transparent • Quick rewards for success and punishment for failure • Responsiveness to business environment • Disadvantages: • May encourage “short-termism” • Mergers and takeovers do not always work

16. Practice of Governance: Germany • Banks have very large shareholdings in major corporations • Long-term (cosy?) relationships • Other shareholders are proportionately less important • Hostile takeovers virtually unknown (exception: Vodafone/Mannesman)

17. German Governance: Assessment • Advantages: • Long-term business relationships • Stability of employment and production • Social cohesion? • Disadvantages: • Lack of transparency and openness • Sometimes tolerant of poor performance • May be unresponsive to global change

18. Practice of Governance: France • Shareholding structures more like Germany than UK • Close state-business links, and intervention by the state • Stock market has become much more important over last 20 years - state uses it as a discipline measure

19. French Governance: Assessment • Advantages: • Successful use of state/business partnerships • Coordinated approach to industrial strategy • Effective use long-term planning • Disadvantages: • Conflicts of interest between business/state • Sometimes lack of transparency • Some tolerance of underperformance

20. Practice of Governance: Russia • Large industrial groups, some controlled by the “oligarchs” • Some very big corporations are under strong state influence (e.g.Gazprom) • Stock market not very transparent • Many business relationships based on personal connections, sometimes crime

21. Russian Governance: Assessment • Advantages: • If any at all, the avoidance of disorder • Disadvantages: • Lack of transparency • Corruption • Misallocation of resources • Excessive arbitrary state intervention

22. Changes in European Governance • Most corporate governance systems are tending to converge • Stock markets are becoming more important, BUT • Some shareholders becoming more activist, such as pension funds like Hermes, some unit trust companies

23. QUESTIONS AND ISSUES • Why has Governance come to the fore in the last 25 years? • What are “good” governance and “bad” governance? • In what ways does governance differ in the private and public sectors? • How much difference does it make?