LAW OF BUSINESS ORGANISATIONS Essay Example | Topics and Well Written Essays - 2500 words

LAW OF BUSINESS ORGANISATIONS - Essay Example The principals hand over the running of the corporate body to the management with the aim of benefiting from professional management of such corporate body. The agency theory offers many views of this relationship, as well as prepositions on how this relationship can be nursed in order to benefit the principals. The subject of this essay is to examine the ways in which agency cost theory has influenced company law and corporate governance reform. AGENCY THEORY The Problem to be Uprooted The concerns that the agency theory raises were first raised by Adam Smith. Smith noted that when a business unit grows into a level at which its management is handed over to other members who are not owners, the running of such a business will not be optimized. The new people who are responsible for managing the business lack an equivalent commitment as the owners. This particularly rises because of conflict of interests. Conflict of interests comes up because the agents will want to maximise their b enefits at the lowest efforts while the principals will want to incur the least expenses but with maximum input from the agents to that the principals’ benefits are maximized.1 These concerns were revisited by other scholars, for instance, Berle and Means, but were fortified by the efforts of Jensen and Meckling.2 Jensen and Meckling clearly explained the conflict of interest that often comes up in the delegation of duties by the principals to the agents. They called it the agency problem. They observed that because agents do not own the business unit they are running, there are likely chances that they will commit ‘moral hazards’. Moral hazards in this context are actions that benefit the agents but at the expense of the business unit or rather the business unit owners. Such actions as shirking duties to attend to personal matters arise when non owners of a business start running it. Such actions are clearly not in the best interest of the principals.3 In order to solve the agency problem, two suggestions were made. One was that the delegation of duties and that the relationship between principal and agent must be designed in a manner that will uphold efficiency. The second suggestion made was that there has to be an effective means of monitoring the agents. Jensen clarified that in the first suggestion, there has to be consensus on the amount of rights that the principals will transfer to the agents. The agents have to be allowed enough rights to allow them execute their duties as pertains to those rights but they should not be too much to the extent of undermining the principals’ rights. And in the second suggestion a mechanism is created that will monitor the agents to ensure that what is agreed in the first suggestion is being adhered to – that is, the agents do not overstep their mandate. Thus from the very outset, the agency theory is all about corporate governance and company law. Putting up structures to enable agents manage a corporate body in a certain way that the principals wants is actually influencing how corporate governance is undertaken.4 It is clear that even though principals invite agents to run their business for efficiency purpose due to the professional skills that these agents have, the agents to some extent are not likely to work as hard as the principals would have worked if they had the skills that the agents possess. It therefore becomes inevitable that the corporate body will lose some value due to the change