LECTURE AGENCY THEORY

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LECTURE AGENCY THEORY
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ME
Sven-Olof Yrjö Collin Professor in
Accounting/Corporate Governance Teach in
management control, strategy, method,
corporate governance Research in corporate
governance (riding schools, municipal
corporations and executive compensation),
accounting choice, auditing E-mail
sven-olof.collin_at_hh.se Home page
www.svencollin.se Phone not in use
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AIM OF LECTURE

• TO SHOW
• - THE RELEVANCE OF AGENCY THEORY
• - THE LIMITATION OF AGENCY THEORY
• IN THE CONTEXT OF THE CORPORATION

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PERSPECTIVE

• Ownership of the firm
• is an irrelevant concept
• Eugene Fama, 1980

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POINT OF DEPARTURE

• Division of labour
• ?
• Productivity of specialisation
• but
• EXCHANGE

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EXCHANGE

• Human interest and beliefs ?conflict
• Limited knowledge because
• lack of information
• lack of theories
• Compensation level risk (variance)
• Violence monopolised by the state
• ?

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HUMAN CONTROL

• Incomplete knowledge Human Interest ?
• Measuring
• Monitoring
• Risk sharing
• Socialisation
• ? inducing a person to act in accordance to your
  will in the exchange

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ASSUMPTIONS OF HUMAN BEHAVIOUR
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ASSUMPTIONS OF HUMAN BEHAVIOUR cont.
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FOUR BASIC THEORIES

• AGENCY THEORY
• TRANSACTION COST THEORY
• INSTITUTIONAL THEORY
• MARXISM

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AGENCY THEORY
The contractual nest
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IMPORTANT CONCEPTS

• BOUNDED RATIONALITY lack of information theory
• RISK sensitive to outcome variance
• ASSYMETRIC INFORMATION information distribution
• MORAL HAZARD effort variance due to bounded
  rationality (what the agent do)
• ADVERSE SELECTION misrepresentation due to
  bounded rationality (what the agent claim)

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SOME ISSUES

• EXECUTIVE COMPENSATION
• BOARD OF DIRECTORS
• MINORITY EXPLOITATION
• FAMILY FIRM
• ACCOUNTING AUDITING

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EXECUTIVE COMPENSATION

• MONITORING PROBLEMSgt INCENTIVE SCHEMES, I.E.,
  BONUS OPTION.

Listed corporations in USA 100 option
schemes Listed corporations in Sweden 44 option
schemes
USA
CEO autonomy
Sweden
Causality?
Japan
Probability of option schemes
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BOARD OF DIRECTORS

• Dependent directors independent directors
  (networks of corporate power)
• Duality, i.e., CEO and Chairperson identity
  (Anglo-American problem)
• Size
• Closed societies (black box)

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MINORITY EXPLOITATION

• European problem?
• Strong owners (state, family, corporations)
• Strong banks
• Dependent CEOs and Top Management Teams (TMT)
• Coalition Owners debt holders (banks) CEO,
  TMT gt Exploitation of minorities
• Empirical evidence? Some in Italy, no indications
  in Sweden

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FAMILY FIRMS

• Kinship management (shirking by family members gt
  demoralizing)
• Family goals more important than corporate goals,
  such as profit
• Information asymmetry (information enclosed
  within the family)
• Irrational conflicts due to kinship, not strategy
  and market considerations
• etc
• Decline growth due to risk of loosing control
• Less competitive due to, for example, more
  limited managerial labor market, kinship
  management
• More risk due to limited capital supply due to
  information asymmetry, non-capitalistic goals,
  family values etc

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POSITIVE ACCOUNTING THEORY
AGENCY THEORY IN ACCOUNTING

• the only accounting theory that will provide a
  set of predictions that are consistent with
  observed phenomena is one based on self-interest
  
• (Watts Zimmerman, 1979300).
• - Watts RL, Zimmerman JL. (1979), The demand for
  and supply of accounting theories The market for
  excuses. The Accounting Review LIV273305.
• - Watts RL, Zimmerman JL. (1986) Positive
  accounting theory. New Jersey Prentice-Hall.

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ECONOMIC CONSEQUENCES

• ACCOUNTING POLICY CHOICE,
• LACKING DIRECT CASH FLOW INFLUENCE,
• CAN INFLUENCE THE VALUE OF THE FIRM
• BECAUSE
• - INEFFICIENT CAPITAL MARKET
• INDIRECT WEALTH EFFECTS
• FOR MANAGEMENT
• FOR THE FIRM
• FOR INVESTORS
• FOR DEBT HOLDERS
• FOR SOCIETY,
• I.E. MOST STAKE HOLDERS

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IMPLICATION OF IMPERFECT MARKETS

• ADVERSE SELECTION
• Valuation of a corporation
• ACCOUNTING REGULATION gt STANDARDIZATION OF
  INFORMATION
• AUDITING gt CREDIBILITY IN ACOCUNTING INFORMATION
• Bad accounting standards and auditing gt
  Information uncertainty gt
• Uncertainty has a price Risk premium.
• (compare buying of a used car)
• gt Accounting and audit choice have price effects
  in imperfect markets

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LIMITATIONS CRITIQUE
HUMAN BEHAVIOUR
INSTITUTIONS
HONOUR
DUTY
Bounded rationality primary socialization
Irrational behavior
Bounded rationality secondary socialization
INSTITUTIONAL THEORY
YET TO BECOME BEHAVIORAL FINANCE