Question

BUSINESS FINANCE

Question 1

As companies grow in size, it is inevitable for the shareholders to hire management to run the operations of the business. The entire team of

management, starting from the CEO and other top-level management, all the way to the middle and bottom level management are expected to

perform towards the growth of the business. Since the shareholders of large companies are scattered across geographies, they appoint certain

members as representatives who are elected to represent them on the company board. The board of directors of a company, along with the

Chairman, are expected to keep the actions of the management in check.

Explain the above in context of agency theory and corporate governance. What can companies do to ensure adequate corporate governance?

Answer 1

The shareholders are owners of the company and thus the ultimate objective of the company's management is to maximize shareholder's wealth. As stated above, due to the sheer number of shareholders, it is not possible for everyone to be directly involved in the day-to-day activities of the company. The Chairman and Board members are elected as representatives of the shareholders to ensure that the Management acts in their best interests.

In the above context, companies can do the following in order to ensure adequate corporate governance :

• Timely audit of financials of the company by independent parties such as Auditors, Consultants etc.Regulations accross developed and developing economies mandate the companies to publish audited results every quarter
• It has been observed in various cases that a professionally managed companies perform better than companies managed by Promoters or Founders. Professional managers tend to make independent decision in the interests of all the shareholders (including minority shareholders)
• Regular Board Meetings - Board of Directors shall regularly meet under the supervision of the Chairman to assess the financial and operational health of the company. Important matters must be discussed from all the perspectives and shall be voted upon
• Diversity in The Board as well as the top management enhances Corporate Governance. Diversity in gender, educational and professional backgrounds, age etc. could help the company to evaluate decisions from a holistic point of view
• Monitoring of top management's performance - The Board must be held responsible to assess if the CEO and other top management members are fulfulling the company's objective. Objectives of the company must be aligned with specific timelines (such as 5 year plan) and the performance of the CEO must be evaluated based on the plan. Moreover, compensation of the management must be based on specific criteria (for instance, compensation can be linked to profitability instead of revenue growth) to ensure long-term growth of the organization
• Transparency - Information must be transparently shared not only with the Board of Directors but with the shareholders at large. AGMs and EGMs can be effective platforms to share the mission, objectives and action plans of the organization in detail. Records of the company must be easily accessible to shareholders and public in general.
• Independent Committees such as Audit Committee, Remuneration Committee etc. could be formed to frame and establish robust internal processes to identify and effectively mitigate risks