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Agency Theory / Role of Corporate Governance - Coggle Diagram
Agency Theory / Role of Corporate Governance
Agency Theory
Modern corporation is based on the principal-agent relationship
The owner (shareholder) is the principal and the manager is the agent
The two enter into a contract whereby the manager acts as the custodian over the assets of the firm and aims to maximise the owners wealth
Agency problem
The manager or agent may pursue their own interests at the expense of the principal
EG Bernie Madoff
Solutions to the problem
The principal will incur agency costs to monitor the agent's activities and take corrective action where necessary
Agency costs are direct and indirect costs arising from the disagreement or the inefficiency of a relationship between shareholders and business managers
Director costs
Use of company resource for the agent's own benefit eg excessive pay
Monitoring costs such as fees payable to external auditors to assess the accuracy of the company's financial statements
Indirect costs
Lost opportunities that arise out of the shareholder/management conflict but does have a directly quantifiable value
The role of corporate governance
Part of the monitoring process
Internally adopted mechanism by which control is exercised by the board of directors over the activities of the managers
Refers to the set of internal rules, policies and processes that determine how a company is directed
Corporate governance framework can play an important role in helping boards gain a better understanding of their oversight role
Seeks to enhance financial reporting by providing a degree of confidence to the users of accounting information