Jensen & Meckling (1976) and Fama & Jensen (1983) stated that type I agency problem is a conflict of interest between the owners and the managers of a company. This conflict often occurs when the company is large in size. The owners of the company, also known as the principals, entrust managers, known as the agents, to act on their behalf. The agents are expected to act in the best interest of the principals but agents often has different objectives than principals.Unlike shareholders, managers have higher authority power in the company because shareholders have no day-to-day control.
The asymmetry of information occurs as managers commonly have better information than shareholders about the running of the business and first hand facts that shareholders do not know. As a result of this, it leads to moral hazard. This is a situation when one party that is insulated from risk might act differently than if it were exposed to the risk. Thus, moral hazard arises because interest between managers and shareholders are not aligned. Which then causes conflicts between them. For example, according to Masulis (1988, p. 48), managers prefers less work, so they will choose high consumption level of work as it would not affect their remuneration and and shares they own in the company.
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The deviation between the interests of the two party is known as the agency cost and the ideal way to reduce this is by providing appropriate incentives to align the interests. For example, bonus payments can be offered to managers as an incentives for them align their interests with shareholders. Therefore, managers who focus on their own interest, then conflicts between owners and managers arises, so shareholders might provide manager appropriate incentives to reduce it be circumstances that expect to seen in agency problem I. Berle and Means (1932) stated that agency problem I will mitigate when the ownership is concentrated in a small group or a single person as they will have the authority and monitoring power that lead managers to make decisions which is beneficial to the principal’s objective. This is known as concentrated ownership and it occurs when an individual shareholder owns at least 5% of equity stock within the company. Concentrated ownership leads to type II agency problem when large shareholders use their controlling position in the corporation to get their own private benefits at the expenses of small shareholder. This causes a conflict between the majority and minority shareholders as the minorities do not have the power to fight back. However, if the large shareholders are independent owners, the private benefits of control will be diluted.
This will then in return lead to agency problem I as incentives of expropriating the minority shareholders and monitoring manager decrease as well. According to Villalonga & Amit (2006), agency problem II will only overshadow agency problem I if majority of shareholders is an individual or a group of people with trustworthy and close relationship such as a family, as it will enhances its incentives for both expropriation and monitoring.Another circumstances that is expected to appear in agency problem I is dispersed ownership. This can occur even if large shareholders with concentrated ownership are independent owners. even if a company is concentrated ownership when large shareholders are independent owners and it would be type 2 agency problem in family firm.
In other words, agency problem I is commonly found in non-family controlled firm. (B) J. Sainsbury PLC, which was founded by John James Sainsbury and Mary Ann Sainsbury in 1869, currently has approximately GBP 260 share price in the London Stock Exchange. The family sold down their stake between 2005 to 2008 from 35% to 15%. (FAME, 2018). At the moment, there is no descendants of John James Sainsbury or any relation family members working in Sainsbury’s.
They do not hold more than 3% of combined shares in the company. Mike Coupe and David Tyler, who currently serves as CEO and chairman in Sainsbury’s, does not have any relations with the Sainsbury’s family. Sainsbury’s major shareholders are Qatar Holdings LLC and Credit Suisse AG. Both are independent owners with each holding 22% and 11.
4% of the shares.According to FAME (2018), BvD Indicator is identifying the degree of independence of a company with regard to its shareholders and calculates total percentage of ownership. Sainsbury’s is considered as independent, as the degree of Sainsbury’s in this indicator showed A+. This means that in the 126 shareholders in Sainsbury’s, there are no shareholder who holds more than 25% of direct or total ownership.
In addition, the ownership data showed in FAME (2018), indicates that the percentage of share ownership recorded is categorized as voting shares. Therefore, Sainsbury’s has dispersed ownership. However, even if it has concentrated ownership which might cause agency problem II, according to Villalonga & Amit (2006), if the large shareholders are independent owners, it will revert to agency problem I. As a result, it appears that Sainsbury’s is more likely to suffer from the type I agency problem as it is a non-family controlled firm, with large shareholders that are independent owners and has dispersed ownership. Agency problem I occurs when manager act on their own interest rather than owners.
According to Vandevelde. M (2017), David Tyler, chairman of Sainsbury’s used the company’s staff to help with his house’s refurbishment project during working hours. It showed that he used his executive power in the company for his own private benefits and to do tasks which does not add value to the company. This deviates from the interests of shareholders. In addition, Hellier, D.
& Butler, S. (2016) presented that Sainsbury’s bids for Home Retail Group by using £1bn made Qatari investment authority, Sainsbury’s major shareholders uneasy with it and wants to block the deal. Furthermore, they are unhappy that they did not get fully consulted by Sainsbury’s about the bid for Home Retail Group. It shows that interest between shareholders and managers are not aligned and thus causing conflicts that leads to agency problem I that is evident in their company’s historical press.In order to align this conflict of interest, Sainsbury’s could introduce payment of bonus to managers as a mechanism to incentivise managers to perform in the best interest of owners to reduce agency problem I.
It is showed in Sainsbury’s annual report 2017 that no bonus payments were made because overall business performance does not reach their requirements. Thus, bonus payment reinforced the existence of agency problem I in Sainsbury’s. (C) UK Corporate Governance Code was produced by Cadbury Committee in 1992 to ensure a company’s long term success by facilitating effective, entrepreneurial and prudent management. A company is required to apply the main principles of the UK Corporate Governance Code which are leadership, effectiveness, accountability, remuneration and relations with shareholders by the Listing Rule and report to shareholders. Sainsbury’s board structure is made up of board of directors and operating board and has complied with all the provisions of the UK Corporate Governance Code. Board directors comprises of the Chairman, three Executive Directors, and six Non-Executive Directors. First section of the main principles is leadership.
Every company should be headed by an effective board which has a transparent division of responsibilities between the chairman and the chief executive in order to have long-term success. David Tyler, the chairman of Sainsbury’s and the leader of the board, is responsible for setting the board’s agenda and for ensuring that all aspects of its role is effective. Mike Coupe, the CEO should share the leading role with the Chairman. The CEO is responsible for the day-to-day management as well as the strategy, values, organisation, financial objectives and risk appetite by allocating decision making and responsibilities accordingly to achieve good result.Non-Executive Directors should constructively challenge and help develop proposals on strategy by criticizing the performance of management, ensuring financial information is integrated, strong financial controls and system of risk management and set executive directors’ remuneration appropriately. Susan Rice, Senior Independent Director who is one of the independent non-executive directors, appointed by them to act as sounding board for Chairman and intermediary for the other directors.
For example, Sainsbury’s held meetings that the Chairman and Non-Executive Directors met without the Executive Directors, and the Non-Executive Directors also met without the Executive Directors or the Chairman which is under one of the Code provision of Leadership. Sainsbury’s is headed by an effective board and clear vision of responsibilities shows it comply with the Code successfully. Second section of main principles of Code is effectiveness and there are 7 of main principles under this section, which is the composition of the board, appointments of the board, commitment, development, information and support, evaluation and re-election. The board and its committees will present their duties and responsibilities effectively by having rightful balance of skills, experience, independence and knowledge of the company. Sainsburys’ chairman satisfied the independence criteria of the Code on his appointment to the Board. Another main principles of this section showed in Sainsbury’s is that non-executive directors were able to undertake additional commitments, so it confirms that each non-executive director is able to allocate sufficient time to discharge their responsibilities effectively.
Sainsbury’s held induction programme for directors and programme for meeting Directors’ training and development requirements such as regular presentations from management and informal meetings to which comply with the Code. For example, Brain Cassin visited new store at Nine Elms, attended by a colleague listening group and met external advisers to have an understanding of his own obligations and regulations. Besides that, Sainsbury’s managed to comply the Code with board evaluation. The Chairman provided feedback of performance evaluation of each directors on their individual contributions to the Board. The senior independent director reviewed the Chairman’s performance and provided him with feedback. Sainsbury’s appointed Manchester Square (MSP) to conduct the evaluation exercise of the Board and its committees as well and MSP concluded that performances of the Board is first class. The third main principles of Code is accountability, which has three small sections including financial and business reporting, risk management and internal control and audit committee and auditors. First section is the Board should present a fair, balanced and understandable assessment of the company’s position and prospects.
Sainsbury’s Company Secretary and Corporate Services Director, Tim Fallowfield stated that the Directors prepared the Group’s financial statements in accordance with the IFRSs as adopted by the EU which based on the Code in the annual report 2017. Second section is the Board is responsible for achieving its strategic objectives by deciding the nature and extent of the principal risk that they willing to take. Risk management is carried out by Sainsbury’s by taking some risk management process and supported by a divisional risk management process. Internal controls system include controls relating to financial reporting processes, operational and compliance controls ae well as risk management processes. It also includes controls over Sainsbury’s interests in joint ventures. The last one is audit committee and auditors. The Audit Committee of Sainsbury’s is chaired by all independent Non-Executive Directors, David Keens, with Matt Brittin and Brian Cassin. This involves corporate reporting and risk management and internal control principles established by formal and transparent arrangements for auditors by the Board of Sainsbury’s and to maintain an appropriate relationship between them.
The forth main principles of Code is remuneration. Executive directors’ remuneration should ensure transparent, stretching and rigorously applied when considering performance of staffs in the company. Besides that, the policy on executive remuneration and fixing remuneration packages of individual directors should have a clear procedure.
Non-executive directors are not allowed to have share-options or other performance-related elements in their remuneration. As evident in Sainsbury’s annual report, the non-executive directors have only will received fees and certain benefits.The board should have at least three remuneration committees and in Sainsbury’s these committees are Mary Harris, John McAdam, Susan Rice and Jean Tomlin. According to Directors’ remuneration policy of Sainsbury’s, the annual bonus and Deferred Share Award are used as performance measures and incentives directors for better performance. The Future Builder performance is introduced as a long-term incentives for senior managers and executive directors. However, the remuneration committee has recovery provision on all incentive award in the event such as mis-statement of financial results, damaging reputation, serious misconduct or fraud.
In the event that these happen, Sainsbury’s can call back and retrieve the given incentives within a two-year period. Fifth main principles of Code is relations with shareholders. The board has to make sure that shareholders have satisfying dialogue with them based on the mutual understanding of objectives by using annual general meetings (AGM) to communicate and to encourage their participation. Sainsbury’s held the AGM on 5 July 2017 to offer shareholders the opportunities to meet and question the Board. Mike Coupe, Kevin O’Byrne, James Collins and the Head of Investor Relations are responsible for the AGM. Besides that, Susan Rice, the Senior Independent Director, must be available to attend meetings as required with the Chairman, institutional shareholders and other large investors to present the company’s interim and full-year results which required by the Code to ensure shareholders understand about company.
The senior independent director should have understand issues and concerns of major shareholders by attend meetings with them to listen their views. This shown in Sainsbury’s annual report as the Board received regular feedback of the views of major shareholders. In addition, The board should state the steps they have taken to ensure that the members of the Board and non-executives directors fully understand views of major shareholders. Sainsbury’s have shown this by Makingson Cowel provided relations consultancy services to the Company and external analysis on the views of investors and sell-side analyst