AGENCY ECONOMICS AND INTERNATIONAL COMPARISONS OF CORPORATE GOVERNANCE SYSTEMS

Organisational Economics 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 There are two major branches of OE: Agency theory regards the firm as a series of contractual relationships between owners and workers

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

Basic Points of Agency Theory Organisations: series of contractual relationships between agents and principals Organisations: series of contractual relationships between agents and principals Goal: efficient arrangement (lowest agency costs) of agent-principal relationships. 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

Basic Points of Transaction Cost Perspective Organisations: series of transactions, some within the Org, some across the Orgs boundaries Organisations: series of transactions, some within the Org, some across the Orgs boundaries 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. 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

Types of Transaction Costs Small Numbers Bounded Rationality Opportunism Information Asymmetry Asset specificity 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

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

Moral hazard: workers will not supply the agreed-upon effort 2- Opportunism 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

Costs are incurred in gathering additional information and using various governance mechanisms 3- Information Asymmetry 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

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

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

The Perrow Critique Agency theory focuses too much on the problems of agents behaviour, while ignoring that the principals often engage in opportunistic behaviour 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. * Charles Perrow; Emeritus Professor of Sociology; Yale. The theory presents too dismal a view of human beings interactions 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

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

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

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

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

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

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

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

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

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

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

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