Agency Theory : A Important Function Of Board

1725 Words Sep 9th, 2015 7 Pages
2.5 Agency theory:
Another important function of board is to monitor the managers’ behaviour. Agency theory states that the interest of manager conflicts with that of shareholders and managers may behave opportunistically to pursue self-interest and harm the corporate performance (Jiraporn et al, 2008). The board of directors act as internal control mechanism to monitor managers which include CEO and executive directors.

Prior researches offer the three main reasons of the conflicts between shareholders and managers. Firstly, managers tend to put emphasise on investing cash flows regarding paying dividends, though this investment do not have much profitable return in the future. This tendency may be caused by the more wages, reputation and power. Secondly, managers dislike investments with many risks in comparison with shareholders for the reason that shareholder can reduce the risks by their portfolio choice, while manager cannot. Thirdly, managers prefer pursuing the short-term investment when they make the development decisions which can create immediate results. This behaviour leads managers to invest less capital in the research and development expenditures and relevant maintenance (Vafeas et al., 1998).

Furthermore, due to the failure of Enron and Lehman brothers etc., investors and regulators have doubted the potential issue of internal control exiting in the corporate governance. The U.S enacts the Sarbanes-Oxley Act of 2002 attempt to improve governance mechanism…
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