Agency that individuals will act in the own

Agency problems occur when the management of a
business is separate to the ownership of the business. this often occurs when a
business in made public and floated on the stock market release the some if not
all of the owners wealth. The company is then owned by the shareholders and ran
by managers employed by the business.  A
type I agency problem occurs when there is a conflict of interest between the principal
(shareholders) of a business and the agents (managers) of the business. Whereas
a type II agency problem involves one shareholder dictating how the company is
run for there own interests and no regard for felo shareholders. with a type I
agency problem The assumption is made that individuals will act in the own self
interest therefore owners and managers goals will not be aligned as they both
have conflicting goals for the business.  Managers acting in there own interests to
satisfy there own ambitions e.g. increasing there personal wealth or increasing
there job security, is the cause of this type I agency problem. One example of
the type I agency problem is when management grow the company as much as they
can making less likely to be taken over by another company as it is too big.
This is done to increase the job security of the management as often in a
takeover the management of the company that is bought out are replaced. This
goes causes  a problem for the
shareholders as growing the company quickly may reduce the profitability
greatly and reduce the size of any dividends thus reducing the shareholders
potential wealth.

 

Type I agency
problems happen in companies which have a large dispersion of ownership meaning
there are many different share holders and no one shareholder has a majority skate.
The ownership of the company will typically have many shareholders all with
small shares and not one shareholder with over 50% of the shares.  This means that the managers are not dictated
too by one shareholder as nobody has majority ownership. The shareholders have
relatively small shares of the business therefore there is less incentive to monitor
the performance of the managers of the business. this means the managers are
able to act in there self interests as they know more about the business that
the shareholders do. Managers can carry out creative accounting and earnings
management in order to make the businesses performance look good as well as
enabling the managers to receive both financial and non-financial perks. One
the other hand type II agency problems occur when a large shareholder uses their
majority stake to dictate how the company is run taking advantage of the
smaller shareholders who have no say. These majority shareholders are normally
wealthy families or banks. British companies will typically experience Type I
problems as a pose to Type II problems as British companies tend to have much
more spread ownership than companies in Europe and the Middle East. This spread
ownership allows type I agency problems to occur.

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B)

The Ownership
and structure of a business can show whether it is likely to suffer from agency
problems and which type of agency problem is likely to occur. The company I
have chosen to analyze is J.Sainsbury PLC. I have collected the ownership and
management data from FAME, which provides detailed information on UK and Irish
companies. This data has made me expect the business to suffer from type I
agency problems.

Firstly for a
business to suffer from agency problems it must have principals and agents. As
J.Sainsbury PLC is a public limited company it has shareholders separate from
the company. These shareholders are the principals and the managers are the
agents. By being separate it allows the shareholder and managements interests
to be different as they have different agendas and goals, which affects the
business in different ways, this causes a agency problems as manager have
conflict of interest.

Secondly
J.Sainsbury PLC has a very dispersed ownership meaning that there are many
shareholders all will small shares of the business. There are 113 shareholders
with the largest share being 21.99%. The 2 largest share holders have a
combined share of 33.54% so even if they worked together they are not
guaranteed to win a shareholder vote which intern means that the could not
dictate how the business is run. Having a spread ownership means that the
company is unlikely to suffer a type II agency problem, as there are no
majority shareholders. This means if the business was to suffer agency problems
in would suffer type I as a pose to type II.

However as the
business is public is has more regulations that is has to comply with. These
include more detailed financial reporting, which is in line with the UK corporate
governance code. Managers will find it more difficult to increase the pay of
perks through creative accounting and earnings management as it will be harder
to hide from the shareholders as the new reporting gives shareholders much more
info about the company’s performance. Reporting standers will reduce the
possibility of type I agency problems occurring at Sainsbury’s.

I believe that
as human nature doesn’t change, there will always be agency problems and in the
case of J.Sainsburys PLC they will be type I problems due to its ownership
structure. However I believe that the problems will be limited, as IFRS has
made managers and shareholders knowledge about the company a lot closer.

 

 

C)

The UK corporate
governance code is a framework of principals by which companies in the UK
should be run. The main 5 sections of this code are leadership, effectiveness,
Accountability, Remuneration, relations with shareholders. The board of
directors are responsible for ensuring the company is run inline with these
principals. The board is elected by the shareholders and therefore act on
behalf of them. These set of principals are not a legal requirements but a set
of recommended rules. Because of this there is a regulatory “comply or explain”
approach, which stated that if a company decides not to comply with these
regulations, it must explain publically why it is nit doing so. I believe that
J.Sainsburys PLC complies with the UK corporate governance code fully as they
have released a compliance statement in 2017, which states ‘the company has
complied with all provisions of the uk corporate governance code’.

            
The first main principal of the UK corporate governance code regards the
leadership of the company. A.2: The board of directors is lead by the chair who
must be non executive and a separate person to the CEO. The chairman of
Sainsbury is David Tyler who is a non-executive and the CEO is Mike Coupe.
These two roles of the board are filled in compliance with the UK corporate
governance code. This compliance is essential for shareholders as many company
in the past who had an executive chair who was also the CEO were found to be
dominating the Board of directors and causing agency problem I and which in
some cases lead to business failure. It is essential for the shareholder to
have an independent chair as there is less of a conflict of interest as there
soul aim is to make money for the shareholders, as they are the people who
elect the board.

Another
principal is that he the board should be effective and for this to happen it should
be mix of skills, knowledge, experience and independence. In particular B.2.1.
states that “A
majority of members of the nomination committee should be independent
non-executive directors”. Sainsbury’s board complies with this, as 7 out of the
10 directors are non-executive. Complying with this is particularly essential
for the shareholders as having more non-executive directors ensures no
decisions are made in the interest of the management as the non-executives are
working on behalf of shareholders therefore will reduce the chance of agency
problem I occurring. A lack of compliance would see the many of the decisions
made by the board in the interest on the managers and no the shareholder as the
executive will inherently want to look after them self’s. This would reduce the
value of the company and therefore the share price would reduce which in tern
reduces the shareholders wealth.

The remunerations part of the code states in section D.1: ” Executive directors’ remuneration should be
designed to promote the long-term success of the company”. This means that the
executive directors pay and bonuses should not encourage them to make decisions
with short term benefits as this would not increase the longevity of the
company. Many share holders will want the company to be long standing as the
shares will be passed through there generations of there families in a passive
investment style and they will jot want the company to only be safe I the short
term. To decide the pay of the executive directors, a remunerations committee
is formed which the code states in D.2.1 “the board should establish a
remunerations committee of at least three, or in the case of smaller companies
two, independent non-executive directors”. Sainsbury’s have fully complied with
this as their remunerations committee consists of Matt Brittin, Jo Harlow and
chaired by Susan Rice. These are all independent non-executive directors and
have the shareholders best interests in mind when designing remuneration
packages for the executive directors.

The remunerations for the executive directors
should be designs in a way in which the longevity of the company is encouraged.
The UK corporate governance code states “For share-based remuneration the remuneration
committee should consider requiring directors to hold a minimum number of
shares and to hold shares for a further period after vesting or exercise,
including for a period after leaving the company”. The share based
remunerations are uses at Sainsbury’s as it is shown 2 out of the 3 executive
directors all hold shard in the company. By requiring the directors to hold the
shares for a period after leaving the company it will firstly eliminate the
chance of them carrying out insider trading, it will also encourage directory
to run the company in a manor that is sustainable as they will want there
shares to have a high value on the feature and not just the present. By giving
the executive director shared in the company it will encourage them to work on
behalf of the shareholder even more so as they are on themselves.

 

The final part of the UK corporate governance
code regards the relationship with shareholders in particular E.1.2.  “The board
should state in the annual report the steps they have taken to ensure that the
members of the board, and in particular the non-executive directors, develop an
understanding of the views of major shareholders about the company”. Sainsbury
have stated in their annual report that they have “the company regularly met
with large investors and institutional shareholders” and “large investors and
institutional shareholders also visited a number of stores and concessions”.
This is evidence that the company has met with the shareholders and in tern
developed an understanding into there views of the company. Without these meeting
shareholders would have very little input into how, the company they partly
own, is run. Not only is this bad for the share holders as they cannot express
there view n the way the company is run, but also the company, as it would not
attract potential investors to buy shares for this vey reason. The meetings
with shareholders are essential in reducing and un-alignments in knowledge of
the company with will put the shareholders at ease regarding agency problems.

I believe that J.Sainsbury PLC fully complies with the UK corporate
governance code as they have stated and shown how they have done so. I believe
there is more of problem in a company does not comply with UK corporate
governance code and provides an explanation. Although these explanations may be
true and necessary for a business many of these explanations can often be a
method to facilitate creative accounting and earnings management. This
increases the knowledge gap between shareholders and a manager, which is a
problem for shareholders as they cant, be confident in their investment. On the
other hand, fully complying with the UK corporate governance code can be
expensive for a business and has a knock on effect of reducing the dividend pot
and therefore yield for the shareholder. There are problems with both complying
and non-compliance however it is clear that compiling with the UK corporate
governance code gives a better picture on how the business is being run and
therefore beneficial to the shareholders.