A Critical Factor In Economic Development Accounting Essay

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Prowse argues that a principal agent relationship is motivated solely by self-interest. Shareholders goals are to maximise their wealth regardless of the value of debt, whereas the agent (manager) wishes to maximise their remunerations. Jensen and Meckling (1999) address this problem as 'separation of ownership and control'. Enron which is one of the world's greatest scandals shows the extent of drastic impact that can take place as a result of the agency problem.  There are two reasons that the problem arises. Firstly under conditions of information asymmetry, adverse selection and moral hazard, secondly there is a certain amount of risk that is apparent when the principal and agent have different attitudes towards risk (Eisnenhardt m .k.). The Enron scandal arised due to a combination of both the factors. Information asymmetry and moral hazard existed as Enron did not honour their respective relationship with their shareholders and concealed the real value of the company. This was in order to attract and create a healthy portfolio, and the shareholders did not receive their share of Enron and their expected return of investment was not accomplished due to the fact that managers distorted the assets thus the real value of the company was not reflected. This example illustrates the conflict of interests the principal and agent. The managers received more investments so it was perceived as a more successful company and this would increase their creditworthiness and receive higher salaries. As can be seen Agency theory comes with substantial agency costs due to the divergence of interests from parties. Research in the ownership of shares in the FTSE 100 companies has shown that less than 5% of all shares are held by management of companies. This implies that most of the shareholders hold majority of the shares in listed companies rather than management and this is a reason for the separation of control and ownership has led to a misalignment in interests.

 Corporate governance intervened by finding effective mechanisms of reducing  the agency problems caused by the principal agent relationship  and  can be closely seen in the Uk and USA . Under the corporate governance code in the UK : a remuneration committee is required which will make sure that the salaries are fair and based on performance . All companies require external auditors that provide assurance over the financial statement of the company which enables transparency to the shareholders and helps reduce information asymmetry.

Stakeholder theory is any group or individual who can affect or is affected by the achievement of the organizations objectives. Unlike the agency theory whereby managers are working solely for the shareholder, this theory suggests that managers have a network of groups to serve that have a stake such as suppliers, employees, customers and other community organisations with which it co-operates. Quinn and Jones(1995) believe that managers should behave ethically whether profitable or not.  The following example shows that effective stakeholder management can lead to a successful growth of a company. Chrysler treated their supplier as a valued member of the stakeholder network rather than simply a source of material. When the Chrysler was on the brink of disaster, the company responded with price cuts, accepting late payments and financing.  

However there is a problem that is presented with this theory as it can be difficult to determine who the stakeholders are and how many groups to cater for until it affects the effectiveness of a firm's profit.

Stakeholder theory can be seen implemented by many countries in the world. Germany has a legal requirement to take into account the interests of the shareholders and parties beyond. Spindler (2004) shows this is done by a process known as co-determination whereby the shareholders and employees own an equal number of seats on the board. This process has also been adopted Austria. China has a two -board system with a supervisory board above the management board in which the employees account for no less than one third of the supervisory board. They have a requirement that when conducting their business operations must understand their social responsibilities. Japan shows a system whereby the directors are legally obligated to perform their negligence duties including third parties otherwise they will be held liable. France has a system whereby private companies must reserve three board positions to be elected by employees. Even though the UK is has majorly adopted the agency theory, it is slowly enforcing stakeholder values. UK companies' act 2006 and its revision have been in effect

It is now legally required for directors of a company to take into account consequences of the decisions they make, the interest of employees , associations with customers and suppliers , environmental impact as well as effects on local communities. In the UK this is the first time non shareholders are being considered. Developing countries find it difficult to conform with both the theories because they have weak judicial systems and often poorly defined property rights, tend greatly to weaken effective contract enforcement.

All the countries who are stakeholder influenced have different specifics in their systems of governance; however they all share a common objective whereby the parties beyond shareholders are involved in the decisions made in the company.  In all the countries above employees are seen to play a prominent role as they regarded as important stakeholders in the firm

Shankman (1999) argues that stakeholder theory is derived from agency theory and suggests that the theories are not exclusive to each other. This is because agency theory promotes four principles which are to avoid harm to others, represent autonomy of others, avoid lying and honour agreements (Quinn and Jones 1999). These factors should also be incorporated into the stakeholder perspective of the firm. Moreover he believes stakeholder theory leads to value maximisation in the long term and for it to be widely accepted it must incorporate the ideas of reducing agency costs as it also promotes the importance of incentives and monitoring the efficiency of the firm.  Hill and Jones (1999) express a similar and suggest that the stakeholder theory can be viewed as a modification of agency theory. Under the principles of agency theory and their responsibility and accountability, manager's interests need to be aligned with the shareholders as well as stakeholders interests therefore the concepts used under agency theory can be equally applied to stakeholder theory. Freidman believed in a strictly agency approach whereby the only responsibility of a company was to maximise shareholder wealth and not give the shareholders' funds to charities etc. "The business of business is to maximize profits, to earn a good return on capital invested and tobe a good corporate citizen obeying the law - no more and no less."(Milton Friendman 1970). Wheeler and Sillanga() on the other hand suggest a cycle including all stakeholders aimed at continuous improvement of processes, products, performance and relationships.

There are alternative approaches to corporate governance that are used. Donald (1990) suggested an alternative hypothesis called the stewardship theory, which opposes the agency theory. It proposes that directors should be 'pro organizational', more trustworthy and performance should be achieved by a harmony between the directors and shareholders because it insists they both have an interest in maximising the long term stewardship of a company and therefore already well aligned. Another alternative theory is the resource dependency theory which focuses on the role that directors play in providing or securing essential resources to an organization through their linkages to the external environment. This theory emphasises on the role of board of directors in providing access to resources that are required by the firm, whereas stakeholder theory focuses on the care of individuals and a big group of people.


Overall agency theory looks to remove any risk and information issues between the agent and the principal .However with all the evidence gathered we can conclude that the stakeholder theory is a better approach in the 21st century because in order to cater for stakeholders, agency theory problems must be solved, therefore the stakeholder theory encapsulates the agency theory. After many corporate scandals that have emerged there is clear evidence that a stakeholder approach will help enhance efficiency and trust in the financial world thus preventing further crisis.