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Subject 3. Principal-Agent and Other Relationships in Corporate Governance PDF Download
Shareholder and Manager/Director Relationships

Problems can arise in a business relationship when one person delegates decision-making authority to another. The principal is the person delegating authority, and the agent is the person to whom the authority is delegated.

Agency theory offers a way to understand why managers do not always act in the best interests of stakeholders.

  • Managers and shareholders may have different goals. They may also have different attitudes towards risk.
  • Information asymmetry. Managers almost always have more information than shareholders. Thus, it is difficult for shareholders to measure managers' performance or to hold them accountable for their performance.

Controlling and Minority Shareholder Relationships

Ownership structure is one of the main dimensions of corporate governance. For firms with controlling shareholders, separation of ownership and control generates a two-level agency problem: between controlling shareholders and management and between minority shareholders and controlling shareholders. The interests of controlling and minority shareholders are often not aligned.

For example, if a company has two classes of common shares (dual classes of common equity):

  • Class A shareholders have all the voting rights.
  • Class B shareholders don't have any voting rights.

The management team and the board are more likely to focus on the interests of Class A shareholders. The rights of Class B shareholders may suffer as a consequence of the ownership structure.

Minority shareholders have less influence on the board composition than controlling shareholders. Controlling shareholders may receive special attention from management. They are often in the position to facilitate third-party takeovers by splitting the large gains on their own shares with the bidder.

Manager and Board Relationships

This is another example of agency theory (discussed above).

Shareholder versus Creditor Interests

These two parties have different relationships to the company, accompanied by different rights and financial returns. For example, shareholders have an incentive to take on riskier projects than creditors do, as creditors are more interested in strategies that will increase the chances of getting their investment back. Shareholders also prefer that the company pay more out in dividends than creditors would like.

Other Stakeholder Conflicts

There are conflicts among other stakeholders, such as those between:

  • customers and shareholders;
  • customers and suppliers;
  • shareholders and government or regulators.

Learning Outcome Statements

c. describe principal-agent and other relationships in corporate governance and the conflicts that may arise in these relationships;

CFA® 2020 Level I Curriculum, 2020, Volume 4, Reading 31

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