Professional Documents
Culture Documents
Table of Content
Table of Content
Table of Content
Table of Content....................................................................................................................................1
I. Introduction...................................................................................................................................2
01. Main implications of globalization in developing corporate governance practice.....................3
02. Main agency problem from corporate governance perspective..................................................6
03. The agency problems and corporate governance practices in AVIVA PLC.............................10
Reference.............................................................................................................................................16
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I. Introduction
So achieving only one party’s objective (shareholders or managers) will leads to conflicts. So
there should be a mutual beneficial way to resolve this conflict. Therefore separation of
ownership and control of LLCs led to originate the mechanism of corporate governance.
Corporate governance will address how organization should directed and control to maximize
shareholders wealth as well as the others stakeholders.
In the first section of this assignment, it critically discusses main implications of globalization in
the developing corporate governance practices. And from section two, it provides better idea for
the main agency problems in an organization from corporate governance perspective. Finally,
study has selected AVIVA PLC which is a listed company in the London Stock Exchange to
provide an analysis on the agency problems in terms of corporate governance practices.
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1. Main implications of globalization in developing corporate governance practice
Globalisation is a trending concept from the last few decades which has become an important
factor in business life with the emerging technology. This concept is important for the economy,
business life, society and environment in many ways. These changes mostly interrelated with
increasing competition among the competitive firms and greediness for the profits with changing
of technology and availability of information. This situation makes organization more profit
oriented than a long term focus sustainable company. However, Organizations are an important
part of the society which required to be organised properly. Therefore we need rules, principles
and few social norms, in society and business life. This was the emerging point of the role of
governance.
Globalisation affects the economy, business life, society and environment in different ways:
• Increasing competition,
Globalisation makes competition increased and this competition can be related to product and
service cost or price, target market, technological development, quick response, JIT production by
companies, quality aspects and customer satisfaction.
• Technological development,
• Information/Knowledge transfer,
Information is expensive and valuable production fact in the current environment. Information
can be easily exchanged and transferred from one place to another in global context. If a company
needs they has a chance to use updated knowledge and information which means it can adapt to
this global changing within few seconds.
• Portfolio investment,
Globalisation encourages investing in international portfolios and financial markets have open to
international capital flows to invest. For such reason, portfolio investment is one of the major
problems of developing economies since it is almost the only way to increase liquidity of the
financial markets and economies for emerging countries by attracting foreign funds.
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• Regulation or deregulation, International standards,
There are various type of new and complicated financial instruments and methods in the market
with the globalization concept and such instruments easily transfer and trade in other countries
because of the technological support. Every new system, instrument or tool requires new rules and
regulations to determine its impact in such areas.
• Market integration,
Globalisation leads to the conversion of many capital and money markets and economies into one
market and economy. The aim of this to regulations he global markets as a one market and it also
to deregulate the restrictions of all these markets. The economy needs financial structures to be
capable of handling the higher level of risk and return in the new economy
• Intellectual capital,
Human capital mobility through knowledge and information transfers is one of the reasons is that
international/multinational companies have subsidiaries, partners and agencies in different
countries. Such companies need skilled and experienced international employees and need to
rotation from country to country to provide appropriate international business exposure and
practice.
Financial crises are determined through globalisation and as a result of the globalisation impact.
The financial world has witnessed a number of crises in recent years with high impact to the
entire financial market. Generally financial crises result from international funds/capital flows
(portfolio investments), lack of regulations and standards, highly complex financial instruments,
rapid development of financial markets, asymmetric information and insider trading of
information. One country crisis can turn into a global crisis with systemic and unsystematic effect.
Systemic risk reveal to a spreading financial crisis from one country to another country. In some
cases, crises spread even in between countries or continents which do not appear to have any
common economic fundamentals/problems.
Corporate governance protects firms against some long term loss by interrupting in making short
term beneficial decisions. When organizations have social responsibilities, corporate governance
guides them calculate their risk and the cost of failure. Firstly, a firm has to have responsibility to
shareholders and also all stakeholders which means that it has responsibility to all society.
Corporate failures have an important impact on entire society also. Various stakeholders and other
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regulators of the firm have a responsibility to ensure good performance. Therefore, corporate
governance is not only about to firms but also related to all society.
Inadequacies and failures of existing system/regulations leading to need for norms and codes to
remedy them.
Deficiencies and misinterpretations in the accounting standards evident after many organizations
in their eagerness to increase earnings to fulfil the requirements of the management and accelerate
growth, exploited the weakness in accounting standards to show inflated profits and understated
liabilities
Financial crises in the Asian Countries - highlighted the need for improved level of corporate
governance as the lack of it in certain countries has been responsible for collapse of many
corporations.
Differing interest in stake holders- the interest of those who have effective control over a firm can
differ from the interest of those who supply the firm with external finance.
Mismanagement in the company- loss suffered by the investors and bankers on account of
unscrupulous management of the companies which gave raised capital from the market at high
valuation.
Suppression of facts - allotment of shares of promoter’s on preferential prices, disproportionate to
market valuation of shares leading to further dilution of wealth of minority shareholders
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2. Main agency problem from corporate governance perspective
Jensen and Meckling (1976) defined that the firm is based on the conflicts of interest between
various interacting parties include shareholders, corporate managers and debt holders. According
to this study, the agency relationship can be defined as a contract under the one party (the
principal) engages another party (the agent) to perform some service on their behalf. As the result,
the principal will delegate some decision-making authority to the agent.
These agency conflicts derive because of the impossibility of perfectly contracting for every
possible action of an agent whose actions influence both his own welfare and the welfare of the
principal, Brennan (1995b). Therefore the problem arising is how to influence the agent to act in
the best interests of the principal. Agency costs can be viewed as the value loss to shareholders,
emerging from interests between shareholders and corporate managers. Jensen and Meckling
(1976) stated agency costs as the sum of monitoring costs, bonding costs, and residual loss.
Monitoring Costs
Monitoring costs includes the expenditures which are paid by the principal to measure, observe
and control an agent’s behaviour. They may include the cost of audits, writing executive
compensation contracts and the cost of firing managers.
Denis, Denis and Sarin (1997) stated that effective monitoring will be restricted to certain groups
or individuals. Such monitors must have the fundamental expertise and incentives to fully monitor
management. Further, such monitors must give a reliable threat to management’s control of the
company.
Bonding Costs
The bonding cost includes the establishing cost and adhering cost. That cost may include
additional information cost which is disclosures to shareholders, but management will clearly
have the benefit of preparing these themselves. Agents will stop experiencing bonding costs when
the marginal reduction in monitoring equals the marginal increase in bonding costs
Residual Loss
Regardless the monitoring and bonding, the interest of managers and shareholders are still
probably to be fully aligned. Therefore, there are still agency losses arising from conflicts of
interest and these are known as residual loss.
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They emerge because the cost of completely enforcing principal-agent contracts would far exceed
the benefits derived from doing so. This may shows a trade-off between excessively constraining
management and enforcing contractual mechanisms designed to reduce agency conflicts.
Agency problems derive from problems of interest between two parties to a contract and are
almost limitless in nature.
Jensen and Meckling (1976) stated a moral-hazard explanation of agency problems. Expecting a
circumstance where a single manager owns the firm, they build up a model whereby his incentive
to consume private perquisites, instead of investing in positive net present value (NPV) projects,
raises as his ownership stake in the company declines.
This system is effectively connected in companies where ownership structure is assorted and the
majority of the company’s shares are not controlled by corporate managers.
Moral-hazard problems are also identified with an absence of managerial effort. As managers
possess smaller equity stakes in their companies, their motivation to work may reduce. It is hard
to specifically measure such shirking of responsibilities by directors. However, Rosenstein and
Wyatt (1994) stated that company stock prices reduce upon the announcement of the appointment
of an executive director to the board of another company. This would be steady with shrinking
managerial effort being damaging to company value.
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Earnings Retention Agency Problems
Studies found that director remuneration is an increasing function of company size, providing
management with a direct motivation to focus on size growth, instead of growth in shareholder
returns. Jensen (1986) stated that manager’s favour is to retain earnings, but shareholders favour
is higher levels of cash distributions, especially the company has less internal positive NPV
investment projects.
From the retained earnings, managers get b benefit as size growth grants a larger power base,
greater prestige, and an ability to influence the board and award themselves higher levels of
remuneration, Jensen (1986, 1993). This decreases the risk within the company and strengthens
executive job security. However, such a strategy is ultimately damaging to shareholder wealth.
Lang and Stulz (1994) defined that profits to investors in undiversified companies are better than
for those who had tried to decrease their exposure to risk through this diversification.
These problems are arising among shareholders and managers with respect to the timing of cash
flows. Shareholders will be worried about all future cash flows of the business into the
inconclusive future. In any case, managers may just be worried about company cash flows for
their term of employment, based on favour of short-term high accounting returns projects at the
expense of long-term positive NPV projects.
The degree of this problem is uplifted as top executives approach their retirement, or has made
plans to leave the company. Dechow and Sloan (1991) define research and development (R&D)
costs as top executives approach retirement and find that these tend to decline. R&D costs decline
executive compensation in the short-term, and since retiring executives won’t be around to
receive the rewards of such investments, this could clarify the above findings.
This kind of problems may arise because of portfolio diversification constraints with respect to
managerial income. Should stakeholders wish to broaden their possessions they can do so at little
expense with. However, managers are more similar to individuals holdings a single, or very small
number of stocks. Denis (2001) reveals that the majority a company director’s human capital is
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fixed to the firm they work for, and therefore, their income is highly depend on the performance
of their business. As such, they may find to reduce the risk of their company’s stock. Therefore,
they may look to freeze investment decisions which increase the risk of their company, and seek
diversifying investments which will reduce risk, Jensen (1986).
This problem may be increased when executive compensation is made largely of a fixed salary, or
where their specific skills are difficult to transfer from one company to another. In addition, risk
increasing investment decisions may also increase the likelihood of bankruptcy. Such a corporate
event will severely damage a manager’s reputation, making it difficult to find alternative
employment.
When executive compensation is made largely of a fixed salary or their specific skills are difficult
to transfer one company to another, this kind of problems may arise in the company. Further, the
decisions that impact to increase risk may also increase the possibility of bankruptcy. Such a
corporate decision will damage a manager’s reputation by making it difficult to find alternative
employment.
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The company: AVIVA PLC has been selected for the purpose of critically analyse the agency
problems in terms of corporate governance perspective. AVIVA PLC is a listed company in the
London Stock Exchange.
Below is the analysis of agreed upon procedures from the corporate governance perspective
against the results of the actual procedures of the AVIVA PLC.
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12% of agenda time
Significant transactions
and expenditure – 11%
of agenda time
Financial reporting and
controls, capital
structure and dividend
policy – 15% of agenda
time
People, culture,
succession planning and
Board effectiveness –
15% of agenda time
c) Check that the board has appointed a company The Board has
secretary, whose primary responsibilities shall be appointed Ms. Kirstine
to handle the secretariat services to the board and Cooper as the Group
shareholder meetings and carry out other functions General Counsel and
specified in the statutes and other regulations. Company Secretary,
whose primary
responsibilities shall be
to handle the secretariat
services to the board.
d) Check whether the Chairman has delegated to the Chairman prepares the
company secretary the function of preparing the agenda and Company
agenda for a Board meeting. Secretary circulates it
c) Check the minutes of the board meeting by Detailed minutes are
referring the following: kept covering the given
(a) whether the board used a summary of data and criteria. The Chair of
information in its deliberations the Committee reported
(b) the matters considered by the board to subsequent meetings
(c) whether the board was carrying out its duties with of the Board on the
due care and prudence the fact-finding discussions Committee’s work and
and the problems of contention or dissent which the Board received a
may illustrate; copy of the minutes of
(d) the matters which implies compliance with the each meeting of the
board’s strategies and policies and adherence to Committee.
relevant laws and regulations;
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(e) Board’s knowledge and understanding of the risks
to which the finance company is exposed and an
overview of the risk management measures
adopted; and
(f) The decisions and board resolutions.
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key terms of
appointment which are
include Period,
Termination, Fees,
Expenses and Time
commitment.
g) Check that the company discloses the composition The company discloses
of the board, by category of directors, including the composition of the
the names of the chairman, executive directors, board, by category of
non-executive directors and independent non- directors, including the
executive directors in the annual corporate names of the chairman,
governance report. executive directors and
non-executive directors
in the annual corporate
governance report.
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they remain relevant to
the needs of the
company.
Delegated Authority to
sign and execute
necessary documents
required to open and
operate the money
market savings account.
05 The Chairman and CEO
a) Check that the roles of chairman and CEO is Roles of Chairman and
separate and not performed by the same individual CEO are separate and
held by two individuals
appointed by the Board.
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The Risk Committee,
the Governance
Committee and the
Audit Committee
b) Check that the board presents in its annual report, The performance, duties
a report on each committee on its performance, and functions of each
duties and functions. committee have been
included in the annual
report.
Reference
Brennan, M.J. (1995b), ‘Corporate Finance Over the Past 25 Years’, Financial Management 24, 9-22.
Denis, D.J., D.K. Denis, and A. Sarin, (1997), ‘Agency Problems, Equity Ownership, and Corporate
Diversification’, Journal of Finance, Vol. 52, pp. 135-160.
Dechow, P.M. and R.G. Sloan. (1991), ‘Executive Incentives and the Horizon Problem:
An Empirical Investigation’, Journal of Accounting and Economics 14 (1), 51-89.
Jensen, M.C. (1986), ‘Agency Costs of Free Cash Flow, Corporate Finance and Takeovers’, American
Economic Review 76 (2), 323-329.
Jensen, M.C.and R.S. Ruback. (1983), ‘The Market for Corporate Control: The Scientific Evidence’,
Journal of Financial Economics 11, 5-50.
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Lang, L.H.P. and R.M. Stulz. (1994), ‘Tobin’s q, Corporate Diversification and Firm Performance’,
Journal of Political Economy 102 (6), 1248-1280.
Rosenstein, S. and J.G. Wyatt. (1990), ‘Outside Directors, Board Independence, and Shareholder
Wealth’, Journal of Financial Economics 26 (2), 175-191.
Patrick, M. (2001), Agency theory and corporate governance: a review of the literature from a UK
perspective
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