CORPORATE GOVERNANCE&

AGENCY PROBLEMS

Prepared by:

Sherif Rafik Mohamed GAAFAR

MIBA – ESLSCA 40C

Presented to:

Dr. Hussein SEOUDI

• What is Corporate Governance? • Corporate Governance refers to the processes,

structures and information used for directing and

overseeing the management of an institution.

• Also ways of bringing the interests of investors and

managers into line and ensuring that firms are run

for the benefit of investors.

• Involves regulatory and market mechanisms, and the

roles and relationships between a company’s

management, its board, its shareholders and other

stakeholders, and the goals for which the

corporation is governed.

• What is the responsibility of board members?a. Maintaining an awareness of the licensee’s

internal and external operating environment.

b. Diligently performing the job.

c. Exercising independent judgment and not

permitting themselves to be influenced by

another director, by management, or by outside

interests.

d. Avoiding conflicts of interests by inter alia.

• Why is corporate governance important?

• As it directly impacts the company behavior and

performance not only to shareowners but also to

employees, customers, those financing the company,

and other stakeholders, including the communities in

which the business operates.

• Agency theory

• One or more persons (principal) engage another

person (agent) to perform some service on their

behalf, which involves delegating some decision-

making authority to the agent. • Stakeholder theory

• A corporate entity invariably seeks to provide a

balance between the interests of its diverse

stakeholders in order to ensure that each interest

constituency receives some degree of satisfaction.

• Stewardship theory

• The Manager’s objective is primarily to maximize the

firm’s performance because a manager’s need of

achievement and success are satisfied when the firm

is performing well. • Resource dependency theory

• The strength of a corporate organization lies in the

amount of relevant information it has at its disposal.

• The corporate governance framework consists of:-

1. Procedures for reconciling the sometimes

conflicting interests of stakeholders in accordance

with their duties, privileges and roles.

2. Contracts between the company and the

stakeholders for distribution of responsibilities,

rights, and rewards.

3. Procedures for proper supervision, control, and

information-flows to serve as a system of checks-

and-balances, Also called corporation governance.

• Principles of Corporate Governance:-

1. Rights and equitable treatment of

shareholders.

2. Interests of other stakeholders.

3. Role and responsibilities of the board.

4. Integrity and ethical behavior.

5. Disclosure and transparency.

• Regulations

• Corporate governance principles and codes have been

developed in different countries, but one of the most

important guidelines has been the OECD Principles of

Corporate Governance (published in 1999 and revised

in 2004) then the United Nations Intergovernmental

Working Group of Experts developed the OECD on

International Standards of Accounting and Reporting

(ISAR) to produce their Guidance on Good Practices in

Corporate Governance Disclosure.

• Regulations (cont’d)

• This internationally agreed benchmark

consists of more than fifty distinct disclosure

items across five broad categories:-

1. Auditing.

2. Board and management structure and process.

3. Corporate responsibility and compliance.

4. Financial transparency and information disclosure.

5. Ownership structure and exercise of control rights.

• Internal corporate governance controls

• Internal corporate governance controls

monitor activities and then take

corrective action to achieve

organizational goals as follow:-

1. Monitoring by the board of directors

2. Internal control procedures and internal

auditors

3. Balance of power

4. Remuneration

5. Monitoring by large shareholders and/or

monitoring by banks and other large

creditors

• External corporate governance controls• External corporate governance controls encompass the

controls external stakeholders exercise over the

organization, as follow:

1. Competition

2. Debt covenants

3. Demand for and assessment of performance information

4. Government regulations

5. Managerial labor market

6. Media pressure

7. Takeovers

• Systemic problems of corporate governance

1. Demand for information

2. Monitoring costs

3. Supply of accounting information

•Resolving Corporate Governance Disputes

• Countries seeking to create a capital market and

companies seeking to attract local or global capital

must develop a framework that assures investors of:-

I. The assets they provide will be protected

II. disputes related to the company’s governance can be

addressed effectively.

• Resolving Corporate Governance Disputes• Most companies experience corporate governance

conflicts or disputes, although they are less common

for well-governed companies. These conflicts and

disputes frequently involve the company’s

shareholders, board directors, and senior

executives.

• To help companies manage and resolve corporate

governance disputes more effectively, the Forum has

actively promoted the use of ADR (alternative

dispute resolution) processes and techniques since

2007.

• What are the agency problems?

• Agency problems arise if managers and shareholders have

different objectives. Such conflicts are particularly likely when the

firm’s managers have too much cash at their disposal.

• Managers may place personal goals ahead of corporate goals.

• The Agency Problem prevention factors• Market Forces:

The holders of large blocks of a firm’s stock exert pressure on

management to perform

• Agency Costs:

The costs borne by stockholders to minimize agency problems.•

• Do managers really maximize firm value?• No, if the managers are not the owners and they

might be tempted to act in ways that are not in the

best interests of the owners.

• The agency problem is mitigated in practice through

several devices: compensation plans that tie the

fortune of the manager to the fortunes of the firm;

monitoring by lenders, stock market analysts, and

investors; and ultimately the threat that poor

performance will result in the removal of the

manager.

• How can corporations provide incentives for everyone to work toward a common end?

• These problems are kept in check by compensation plans that link

the well-being of employees to that of the firm, by monitoring of

management by the board of directors, security holders, and

creditors, and by the threat of takeover.

• Motivating Managers: Executive Compensation

• There are several different ways to compensate executives, including:-

-Salary.

-Bonus.

-Stock appreciation right

-Performance shares.

-Stock option.

-Restricted stock grant.  

• The role of the rating agencies

• The purpose of rating agency evaluations is to provide

objective analysis of the creditworthiness of a

corporation.

• The work of credit rating agencies has evolved into a

critical function in our financial system.•Who Are the Raters ?• As a current or future issuer of or investor in short- and longer-

term securities .

• Raters also provide reposts about the corporate financial position.

• What Raters Do?

• The ratings process involves the review of public

documents.

• These data are explained and supplemented by

discussions with management on recent performance

and future strategies.

• The evaluations result in credit ratings for specific debt

issues based on the issuer’s ability to repay interest

and principal.

• This is different from the earnings perspective of equity

analysts, who calculate earnings per share; returns on

assets, equity, or sales; the price/earnings ratio; or

market capitalization.

• What Raters Do? (Cont’d)

• Although assignments vary by rating agency, the

general approach to the assignment of ratings is as

follows:-

I. Repayment on time usually is given one of the

investment grade ratings (AAA to A).

II. The possibility of not being paid on time is

considered noninvestment grade (BBB to B).

III. The possibility of not being paid in full is known

colloquially as junk (C).

IV. The fact of not paying is considered as in default

(D).

• How ratings are constructed?

• The precise process in developing a rating is

confidential, although the analysis is known to focus on

industry comparisons, financial performance and

stability, and the quality of management.

• The ratings agencies do not use a formula or standard

template but review each company with due respect for

unusual factors, trends and developments, and various

no quantifiable concerns.

• Rating agency problems

• In effect, the rating agencies are market regulators

without any official status or qualification

requirement. They benefit from practices that could

be considered as abusive.

• An examination of various legal pleadings and other

public documents indicates the following problems.

I. Accuracy Issues

II. Objectivity Issues

III. Coercion Issues

IV. Qualifications Issues.

• So, who’s rating the rating agencies?

• The power and impact of the rating agencies arguably

exceeds the role normally accorded independent.

• In order to appreciate the origin of this status, it is

useful to examine recent rating agency history.

- Moody’s

- Standard & Poor’s

- Fitch

•Nationally Recognized Rating Organization?

• Conclusions

• The CFO has no choice but to work closely with the

rating gencies to elicit the highest possible grade for

commercial paper and bond financings.

• We expect increasing competition among the rating

agencies for business, with the accompanying demand

for access to managers to discuss company activities.

• Any significant business developments should be

communicated to rating agencies prior to a public

announcement.