Conflicts of Interest and their resolution – Directors

Introduction The various stakeholders in a company are likely to have conflicting interests. In particular the interests of directors may not directly coincide with the interests of the shareholders, even though they are working for the shareholders. The purpose of this chapter is to consider these conflicts and look briefly at ways of attempting to achieve goal congruence (i.e. to remove the conflicts of interest).

Directors’ Behaviour Directors are agents for the shareholders and are supposed to be acting in the best interests of the shareholders of their company. However, in recent years they have been accused of having made decisions on the basis of their own self-interest.

Specific allegations include:

  • Excessive remuneration levels
  • Empire building

Chief executives having the aim of building as large a group as possible by takeovers – not always improving the return to shareholders.

  • Creative accounting

Using creative techniques to improve the appearance of published accounts and artificially boosting the share price. Such techniques include capitalising intangibles on the balance sheet (e.g. development expenditures, putting a value on brands, recognising revenue on long-term contracts at the earliest possible time, not depreciating fixed assets). The Accounting Standards Board attempts to cut out creative accounting practices as much as practically possible.

  • Off balance sheet finance

For example, leasing assets rather than purchasing them (although this is now dealt with by the Accounting Standards)

  • Takeover bids

There have been many instances of directors spending time and money defending their company against takeover bids, even when the takeover would have been in the best interests of the shareholders. The reason for this is suggested as being that the directors are frightened for their own jobs were the takeover bid to succeed.

  • Unethical activities

Such as trading with unethical countries, using ‘slave’ labour, spying on competitors, testing products on animals.

Agency theories

Agency theory is the relationship between the various interested parties in the firm. An agency  elationship exists when one party, the principal, employs another party, the agent, to perform a task on their behalf. For example, a manager is an agent of the shareholders. Similarly, an employee is an agent of the managers. Conflicts of interests exist when the interests of the agent are different from the interests of the principal. For example, an employee is likely to be interested in higher pay whereas the manager may want to cut costs. It is therefore important for the principal to find ways of reducing the conflicts of interest. One example is to introduce a method of remuneration for the agent that is dependent on the extent to which the interests of the principal are fulfilled – e.g. a director may be given share options so that he is encouraged to maximise the value of the shares of the company.

Goal Congruence

 Goal congruence is where the conflict of interest is removed and the interests of the agent are the same as the interests of the principal. The main approach to achieving this is through the remuneration scheme – an example of which was given in the previous section of this chapter, that of giving share options to the directors. However, no one scheme is likely to be ‘perfect’. For example, although share options encourage directors to maximise the value of shares in the company, the directors are more likely to be concerned about the short term effect of decision on the share price rather than worry about the long-term effect. The shareholders are more likely to be concerned with long-term growth. An alternative approach is to introduce profit-related pay, for example by awarding a bonus based on the level of profits. However, again this may not always achieve the desired goal congruence – directors may be tempted to use creative accounting to boost the profit figure, and additionally are perhaps more likely to be concerned more with short-term profitability rather than long-term.

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