Question

Describe the differences between principal–agent conflicts and principal–principal conflicts. What kind of corporate governance reforms can be introduced to protect the shareholders’ interest, particularly minority shareholders?

Answer 1

The principal-agent problem occurs when a principal creates an environment in which an agent's incentives don't align with those of the principle. Generally, the onus is on the principal to create incentives for the agent to ensure they act as the principal wants. This includes everything from financial incentives to avoidance of information asymmetry.

These issues are central to the principal-agent problem. The separation of control occurs when a principal hires an agent, and the costs that the principal incurs while dealing with an agent can be defined as agency costs. These agency costs can come from setting up monetary or moral incentives set up to encourage the agent to act in a particular way.

An example of how the principal-agent problem occurs between ratings agenciesand the companies (the principals) that hire them to set a credit rating. Because a low rating will increase the cost of borrowing for the company, it has an incentive to structure its compensation of the rating agency so that the agency gives a higher rating than what may be deserved. The rating agency is less likely to be objective because it fears losing future business by being too strict.

A more common example would be when a person (principle) takes in their car to be serviced by a mechanic (agent). That agent knows more than the typical principle, and the agent has the ability to charge at their own discretion.

Principal- Principal conflicts is a different type of conflict occurring between majority (controlling) shareholders and minority shareholders. This problem is also known as Agency Problem. Key to addressing such principal-principal conflicts is understanding the heterogeneous interests of principals

For example, they may vary in risk preferences and their future growth, family owners seek not only to financially profit from their investment in the firm but also to receive a measure of “psychic income,” or an emotional reward, from owning and controlling a firm with other family members

PP conflicts are often found in emerging and transition economies characterized by concentrated firm ownership and weak institutional support

Agency theory assumes that shareholders as principals of the firm share common objectives such as shareholder value maximization. Managers as agents of principals are assumed to be potentially opportunistic actors that may take advantage of dispersed shareholders and extract firm value for their own benefit.

The protecting minority investors indi­cator set captures changes related to the regulation of related-party transactions as well as corporate governance every year.

They are divided into two types: reforms that make it easier to do business and changes that make it more difficult to do business. The protecting minority investors indicator set uses the following criteria to recognize a reform.

Reforms impacting the protecting minority investors indicator set include amendments to or the introduction of a new companies act, commercial code, securities regulation, code of civil procedure, court rules, law, decree, order, supreme court decision, or stock exchange listing rule. The changes must affect the rights and duties of issuers, company managers, directors and shareholders in connection with related-party trans­actions or, more generally, the aspects of corporate governance measured by the indicators. For example, in a given economy, related-party transactions have to be approved by the board of directors including board members who have a personal financial interest in seeing the transaction succeed. This economy intro­duces a law requiring that related-party transactions be approved instead by a general meeting of shareholders and that excludes shareholders with conflicting interests from participating in the vote.