Agency Problems and the Board of Directors

Agency Problems and the Board of Directors

1. Directors are deemed fiduciaries and need to be loyal and act in good faith.
2. The major conflict of interest within the boardroom is between the CEO and the directors.
3. The key agency relationships are where the board acts as principal to management and where the board acts as agent to the shareholders.
4. Independent directors have to be duly informed and presented with the right incentives to invest their time and so maximize the company’s value.

Corporate statutes provide that the affairs of the corporation are to be managed by, or under the direction of, a board of directors. However, in reality, sometimes the directors do not manage the company; rather, the corporation’s officers do. Directors nevertheless perform important tasks in approving major transactions, counseling management, appointing officers and monitoring the performance of management and the corporation. 

Law Requirement: a corporate entity must have at least a certain number of members, it must meet with at least some specified regularity, it may need to have various committees, and some fraction of directors may be obliged to have some nominal independence from management.

Relationships: 1. Shareholders contribute capital and retain ownership interests. 2. Management makes decisions regarding corporate operations. 3. The board oversees management performance on behalf of shareholders, both in monitoring such performance and intervening to remedy deficient management operations.

Nowadays, the principal role of the Board is to monitor management’s actions, therefore the board is juxtaposed between the shareholders and the management. Directors and officers are deemed fiduciaries because they stand in a position of trust and confidence in relation to their corporation → directors and officers are forbidden to use their position to obtain personal gain at the expense or to the detriment of their corporation. Business judgment rule protects directors from liability for losses resulting from their corporate decisions. Its existence is dependent upon the directors fulfilling both their duty of care and their duty of loyalty.

The major conflict of interest within the boardroom is between the CEO and the directors. The CEO is incentivized to keep the board happy, so as to ensure that he keeps his job and increases his income flow. Directors have some incentives to monitor the CEO and replace him if his performance is poor. However, directors will generally wish to be re-appointed to the board. The CEO plays an important role in re-nominating directors; hence there are also incentives to favor the CEO.

The Board of Directors (Role): A board must be tailored to unique corporate needs, but also be flexible enough to address both matters of ownership and enterprise. Thus, a board should be composed of a group of diverse and adaptive directors, who can collectively adjust the role of the board to the changing environment.