Agency Theory is the dominant theory underpinning corporate governance. The theory arises from economic theory and states that the separation of management from control in firms creates agency issues due to the conflicts of interest between owners(principals) and managers(agents) who are assumed to pursue self-interest (Fama & Jensen 1983; Eisenhardt 1989).  This relationship enables information asymmetry, goal conflicts, adverse selection and opportunistic behaviour by  the agent (Eisenhardt 1989).  The board of directors is one of the internal control mechanism to minimise these agency issues, and they  provide oversight, monitoring and control of management to ensure the alignment of interests between management and investors (Fama & Jensen 1983; Verhoest 2005).  CEO pay is studied extensively as a measure of agency issues, that is, that the relationship between executive compensation and firm performance can be  a mechanism to reduce agency problems or can be the result of agency problems (Bebchuk 2003; Bebchuk & Fried 2005).  Overall the results are mixed on the key question of whether CEO performance pay is effective at delivering improved firm performance, with the majority of research supporting the view that remuneration could be designed that way, but in most cases managers were able to benefit from “windfall earnings beyond their control – they were compensated for luck”  (Goergen & Renneboog 2011, p.1075).

 

Managerial Hegemony

Where agency theory is a failure of the board in some areas, such as minimising excessive executive pay, managerial hegemony theory argues that boards are a legal fiction dominated by management  (Mace 1971).  This instrumental view sees management as gaining increasing control due to the weakness of shareholders exercise of ownership and control, for example, where shareholders are dispersed or passive, and management is self-serving (Kosnik 1987; Hendry & Kiel 2004).  Given the dominance of the professional management within the firm, the board plays a supportive role at best, or at worst, agency issues are dominant and the boards’ role is to certify management decisions and management will resist a stronger role for the board, for example, a strategic or stakeholder engagement role (Jonsson 2005). Critics point to a lack of empirical evidence and a general lack of  research in comparison to other governance theories (Stiles & Taylor 2001).  However, there are examples where boards have failed to “control” management at the expense of shareholders and stakeholders (Nyberg 2011; Curran & Lyons 2013). In Ireland the report into the failure of the Irish banking system identified one institution where “The Managing Director (MD) had been given extraordinary powers by the Board and many staff reported directly to him. In August 1997, the Board had formally delegated its powers for the practical, effective and efficient management, promotion and development of the bank to the MD. This delegation of powers was most unusual given its vague and general formulation. Indeed, it is not immediately  apparent what the limits to this empowerment were” (Nyberg 2011, p.27).

 

State Agencies

The non-profit and state sector is also vulnerable.  For state agencies, the state has the  parallel functions as owner and regulator, and thus the state owners can override the regulatory system and acquire external resources (Aguilera 2005).  As a state agency has the ability to acquire resources, and the  autonomy to pursue their own objectives, this can result in boards of directors as “rubber stamps” with little, if any, power, and no expectation of them to monitor or acquire resources  (Yoshikawa et al. 2014). A rubberstamp board arises where  management dominate all decision taking and the board is symbolic with no meaningful power or influence (Cornforth 2003).   There is some empirical evidence supporting this model in the Netherlands and in the UK, where, for example, some UK SOEs in the National Health Service reported management controlling all decision making (Greer & Hoggett 2000; Veronesi & Keasey 2012; van Thiel 2015).  It is also a feature of many SOEs in emerging markets where the state exercise more  direct control over the organisations and the board operates more as a conduit for information or as a symbolic board (Frederick 2011).

 

Non-Profits

Non-profits are also exposed to managerial dominance and hegemony with evidence that they too can be subject to agency risks (Brickley & Van Horn 2002; Low 2011; Mswaka Olu & Aluko 2015).   Recent examples in Ireland include Positive Action, an Irish non-profit,  where an independent report in 2017 found that “the executive committee/directors failed to put in place an appropriate system of internal control to ensure they met their fiduciary and stewardship responsibilities” resulting in over half of public funds being spend on overseas trips, weekends away, dining, directors’ expenses and complementary or beauty therapies (Cullen 2017). Console, a suicide prevention charity, was subject to criminal investigation, the CEO was ordered to pay back state grants, and the charity was eventually wound-up (Clarke 2017; Cullen 2016).  The board of the Leuven Institute for Ireland in Europe also may have been a rubberstamp board as it was reported to have “a board that is self-renewing but doesn’t renew itself”, and one observer commented that   “It was never clear to me where [the CEOs] interests ended and the institute began” (Murtagh 2017).   The damage done by these events is very real, directly impacting the most vulnerable, the clients of the non-profits, but also the entire charity sector where funding was impacted and trust damaged (O’Sullivan 2014; Carswell 2017).

References

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Bebchuk, L.A., 2003. The Case for Shareholder Access to the Ballot. The Business Lawyer, 59(1), pp.43–66.

Bebchuk, L.A. & Fried, J.M., 2005. Pay Without Performance: Overview of the Issues. Journal of Applied Corporate Finance, 17(4), pp.8–23.

Brickley, J.A. & Van Horn, R.L., 2002. Managerial Incentives in Nonprofit Organizations: Evidence from Hospitals*. The Journal of Law and Economics, 45(1), pp.227–249.

Carswell, S., (2017, Sept 9). Charities Regulator’s investigation secures first prosecution Conference hears importance of “not burying head in sand” if scandal hits a charity. Irish Times. Retrieved Sept 26 2017 from http//irishtimes.com

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Cullen, P., (2017, Jan 23). Governance at hepatitis C group Positive Action “seriously flawed.” Irish Times. Retrieved Sept 26 2017 from http//irishtimes.com

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