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The purpose of this report is going to analysis the corporate governance of the Non-Executive Directors and the theoretical framework of the agency theory. In agency theory, it divided into what is agency theory, what does agency theory try to explain and what are agency problem between agents and board of directors. At last, it provides NEDs, there are four responsibilities of NEDs, advantages and disadvantages and role of NEDs.
According to ICAEW (2005) an agency relationship arises when one or more principals engage another person as their agent to perform a service on their behalf. Performance of this service results in the delegation of some decision-making authority to the agent. This delegation of responsibility by the principal and the resulting division of labour are helpful in promoting an efficient and productive economy. However, such delegation also means that the principal needs to place trust in an agent to act in the principal's best interests.
The agency theory hypothesis arises from the fields of finance and economics. According to Solomon (2010), it indicated that the first detailed theoretical exposition of agency theory presented in Jensen and Meckling (1976), and they defined a transactional relationship with information asymmetry, which is the managers of the company is the 'agents' and the shareholders is the 'principal'.
The agency theory has generally explained the relationship between the principle and agents. The principle employed agents to perform work; agents have responsibility to show the performance to the principle and to the best of their ability. According to ICAEW (2005), it tells as the principle has employed agents to make performance that they should trust the agent can make the best profitability to principals. Principals should give as much power as they can to the agent that they have motivation finish the mission they have and making efficient and productive economy. On the other hand, there must be some problems between principals and agents. People have different opinions, when the situation shows between; it might be able to break off the relation. When agent would like to make some short-term investment for example, but principal may think in the market situation should make some long-term investment. This is because the principal have to take the most of risk of any decision that manage make; they have to averse the risk that they can be expected at the most. They will use the rest of power to intervene if it is necessary.
According to Nicholson and Kiel (2004), Specific elements rather than to describe the corporate governance or the specific behavior of the board of directors, there is a general model, the board of directors as a kind of social phenomenon. As a social phenomenon, many natural systems board display attributes, so we suggest that the social system of dynamic and open board's (Katz and Kahn, 1978). Therefore, the relationship between the frameworks described, the board of directors and corporate performance as a set of interrelated elements will affect the other elements in the system in one element changes. In addition, the board of directors is an open system, will need to interact with the environment in the board of directors, both the external environment and internal environment. We follow Nadler and Tushman (1980) the three basic elements of the system concept. Input the process of a transformation in order to produce different output. Furthermore, Nicholson and Kiel (2004) have defined that effective board should achieve appropriate 'fit' of four main capitals. The first part is the board of directors of human capital, personal knowledge, skills and abilities by the board. In any review, emphasis should be put on the knowledge, skills and a board member of the organization rather than general business acumen ability. The second component of a board's intellectual capital is its social capital. Social capital refers to the social relations of the virtue, of available resources, the board of directors of the implicit and the visible set (adapted from Gabbay and leenders, 1999:3). The third component of board intellectual capital is its structural capital. Capital structure includes a variety of programs, policies, procedures, process and method of developing the board. It can be compiled and / or recessive divided into routine, the board of directors or the elements of cultural policy. The final component of the board's intellectual capital is its cultural capital.
According to Agency theory and Design of Efficient Governance Mechanisms, agents and principal has different position, even their objectives are maximize their own wealth, but agent more likely to sacrifice company's interest to aim their goal. This is because all they need is to hold the power they have got even the value of equity or the incentive of employment has been decrease. However, in the past, the shareholders hold the information and controlling the resources, and now the managers hold and controlling the resources. There are not 100% win in the market, everyone will probably making loss. However, the most important to lead loss of agency problems are the failure of managerial competence and failure of managerial integrity. These two problems are not on the same situation but they are relative, any one of the problem can cause another. For example, if they not the competence to managerial agents, they might lie to the board of directors to make benefits for their selves. In another word, if they lie to the board and get the benefits, which means the board have not competence to manage the company.
According to Fama and Jensen (1983). Ratification mechanisms are mechanisms for validating the decisions of the agent, of giving final approval or veto for an initiative or directive or actionable plan of agent. Monitoring mechanisms are mechanisms for observing, recording and measuring the output of efforts and strivings of the agents. Sanctioning mechanisms are mechanisms for providing selective rewards and punishments to agents for the purpose of motivating them to exert effort in directions that are align with the interests of the shareholders. According to Jensen and Meckling (1976), mangers or directors, for instance, want to maximize their own wealth, power and prestige while safeguarding their reputation, while shareholders want to maximize the value of their assets. These interests often collide, as managers and directors can take actions that increase their power, influence or prestige without increasing the value of shareholders' equity. According to Fama and Jensen (1983), now the modern public corporations' features are based on mechanisms. Shareholders need information to run the company competently and use mechanisms that concentrate decision rights into the hands of top managers and corporate directors affecting an essential separation of ownership and control. This means that a best board is who try to find out the weakness of the agency problems, and try to solve it out.
NEDs system is established in 1940 (2003, Chen Li), the United States government, the investment company act. The NEDs system is to prevent big shareholders of the internal control and management. 1992 ( Solomon, 2010 ), Cadbury reported that the NEDs-'Apart from their directors' fees and the definition of equity, they should be independent of management, not subject to any business or other relationship, may seriously interfere with the independent judgment of movement ". The NEDs are independent in the company, no other financial relationships in addition to directors' fees. The NEDs is to try to stand in the absolute and objective position and guarantee the shareholder wealth. Keep them in the board control is very important condition, avoid internal control of major shareholders and managers. According to Solomon (2010), he pointed out; the number of NEDs should include at least 1/3 of the board of directors. The independence is the key factors of effective decision-making system of NEDs; their qualification is very strict. The NEDs should not any important related links, can influence and the NEDs of the company, the objective judgment, the main benefit management team and company stakeholders (Tan, 2003), even in the past 3-5 years and the next few years. Therefore, the NEDs should be neutral.
According to Peter and Hanson (2009), NEDs is based on however you successful in your corporate career, under aged 45 always cannot sufficient gravitas and general experience to be an effective NEDs. An effective NED has to be worked for more than one company and therefore have more corporate culture. They have the attitudes which are effective combination of curiosity and courage combined with an appropriate corporate culture, supplemented with the right chemistry.
According to Tyson Report (2003), NEDs have four main responsibility of the company. Firstly, NEDs have to provide advice and direction to a company's management in the development and evaluation of its strategy. It tells NEDs should give mission to managements to match the goal they set up; it can encourage managements to work harder and make his best to encourage employment to make the achievement. Secondly, NEDs have to monitor the company's management in strategy implementation and performance. As NEDs have provided advice and direction to the management, they have to superintend the management to see whether he/she can achieve the goal. Third responsibility is to monitor the company's legal and ethical performance. As human being, people are self-fish when stand in front of the benefits. So it can be sometimes has some ethical performance problems. NEDs in this situation have to completely eradicate managements to do it so. At last, NEDs have to monitor the veracity and adequacy of the financial and other company information provided to investors and other stakeholders. Therefore, NEDs have the responsibility to pledge both shareholders and stakeholders interest, to provide information and comprehensive income statements to show how the company run.
According to Byrd and Hickman (1992: p196), "the inside directors provide valuable information about the firm's activities, while outside directors may contribute both expertise and objectivity in evaluating the managers' decisions. The corporate board, with its mix of expertise, independence, and legal power, is a potentially powerful governance mechanism." It describes the different of inside and outside directors, which inside directors should provide information about the firm's goal, plan and any further information until the year end. Moreover, outside director include NEDs, which is outside independent director. This situation only when the outside director has not any relation to the firm. And the outside director has to give objectivity opinion and expertise to give advice to management to make judgment.
According to Steven T. Petra, (2005), some studies found that a company has more outside directors can improve performance (Barnhart et al., 1994; Daily and Dalton, 1992; Schellenger et al., 1989). However, there are some studies do not found that outside independent directors making any improvement to the company (Hermalin andWeisbach, 1991; Fosberg, 1989; Molz, 1988). These happens might because the company's culture, and the board and outside independent directors' decision do not make any benefits to the management decision. According to Steven T. Petra, (2005), audit committees composed entirely of outside independent directors. It tells audit committees have to review of the internal audit department, review the annual report and find out the weakness of internal accounting controls. This clearly the primary role of the importance audit committees and it is protecting other shareholders' beneficial. An independent audit committee is to mix up the reliable and the empirical evidence. On the other hand, according to (Carcello and Neal, 2000; Dechow et al., 1996; McMullen, 1996) while evidence contained in Beasley (1996), some studies has found that an independent audit committee does not make any improvement of the reliability of the financial report.
On the other hand, according to Spira and Bender (2004), discuss that whether NEDs role between contributing to company strategic and monitoring executive colleagues. Both Cadbury and Hampel acknowledged that there may be some tension between the functions that NEDs are expected to fill. Ezzamel and Watson (1997) examined the potential conflict between these roles in some detail. Noting that Cadbury did not alter the legal responsibilities of NEDs, the basic structure of the unitary board or the existing UK system of accountability through disclosure, they concluded that it is unlikely that NEDs can meet the expectations placed upon them within the current framework. A more recent survey (Pricewaterhouse Coopers, 2001) indicated that the tension between the strategic and monitoring areas of their work remained a problem for NEDs, although complaints about monitoring focused on the increasing burden of corporate governance requirements in terms of committees and reporting, rather than their ambiguous position. Stiles and Taylor (2001) attempted to reconcile the tension by arguing that NEDs make use of the control aspect of their role as a diagnostic tool, which plays a part in the strategic element of their contribution. For example, in China, NEDs cannot do anything in the company, and the quit rate of NEDs is rising. This is because one is the structural condition showed abnormal trend. Such as the age older; occupation presentation theory; the title is senior; degree of high-end; equity is zero; the salary is rigid; source of the non-balanced etc. Two independent directors still belong to the vulnerable groups. According to the current board decision to capital rule, so the independent directors a little difficult to play its function and role. Three is the independent directors of the vase. Because our country independent director ownership is essentially zero, and the salary present rigid features, so the enterprise's long-term sustainable development and benefit, term earnings had no effect on independent directors, independent directors in corporate decision-making because of double take attention and reputation based on the occupation, and have a tendency of more omission. Four is the risk awareness of independent directors to increase gradually, the sense of responsibility has gradually increased, but the unbalanced forces in the board of directors failed to thoroughly. (http://topic.yingjiesheng.com/zhengquanjinrong/gongsi/052A3304H012.html)
In short, NEDs is really important for corporate governance, but there are still some disadvantages in NEDs that we have to find out and solve. The key points are how to make NEDs more effectiveness, to increase the ability of NEDs and give more power to them to monitor the management team. To complete relevant legal system perfectly, reform employs qualification system of NEDs are advantageous to guarantee the effect of independent directors and keep their independence. According to this requirement, it needs to improve NED's system from the legislation departments, judicial departments and law enforcement agencies. Therefore, although NED's system has its own problems, it is still effective and executable solution to reduce the agency problem or other corporate supervise issues. Moreover, we cannot expect NEDs can deal with all corporate governance problems.