HOW CORPORATE

GOVERNANCE IS
AFFECTED BY AGENCY
THEORY AND CONFICT OF
INTEREST

Submitted by:

Pauline F. Dacir
Zayla B. Caab
BAL

Submitted to:

Prof. Marlyn Buendia

Agency Theory in Corporate Governance

According to Investopedia, Agency theory is used to understand the relationships

between agents and principals. The principal is represented by the agent in a particular

transaction and is expected to represent the best interests of the principal without regard

for self-interest. In terms of agency theory in corporate governance, it relates to a specific

type of agency relationship that exists between the shareholders and

directors/management of a company. The aim is to represent the views of the owners and

conduct operations in their interest. Despite this clear rationale, there are a lot of instances

when complicated issues come up and the executives, knowingly or unknowingly, take

decisions that do not reflect shareholders’ best interest.

Take for instance the dividend payout policy of a corporation. Majority of shareholders

expect high dividends payouts when the company is making huge profits. With this, they

don’t just enjoy extra cash on their hands, it also increases the current value of the capital

stock they hold. The executives on the other hand, as a part of the long-term strategy,

may decide to retain a large part of profits. Retention could be for a requirement of some

technology advancement or expansion project. In such situations, a conflict of interest

may arise between the shareholders and executives. Such disagreements can create a

feeling of contention between the owners and controllers of the company, often resulting

in inefficiencies and sometimes even losses.

In order to minimize such problems, companies should make solid corporate policies.

Incentives may be used to redirect the behavior of the agent to realign these interests

with the principal's. Incentives encouraging the wrong behavior must be removed and

rules discouraging moral hazard must be in place. Agency theory may be used to design

these incentives appropriately by considering what interests motivate the agent to act.

Corporate governance on the other hand can be used to change the rules under which

the agent operates and restore the principal's interests. Understanding the mechanisms

that create problems helps businesses develop better corporate policy.

Conflict of interest management as prevention of corruption and bribery - in all spheres of

governance

Current political concern over conflict of interest is fuelled by the insight that situations of conflict
of interest contain a particularly high risk of corruption and bribery. Conflict of interest is a situation
in which an alien or undue interest could improperly influence the public interest activities and
decisions ( or activities and decisions taken in the best interest of a private sector entity). The
existence of a conflict of interest is not in itself unfair, but may hold a potential for unfair behaviour,
in short: for corruption. Therefore, as the Australian Anti-Corruption Commission put it: '[F)ailure
to identify, declare and manage a conflict of interest is where serious corruption often begins and
this is why managing conflicts of interest is such an important corruption prevention strategy.' 119
Importantly, this strategy has been pursued across all spheres of governance, and is itself a
manifestation of the ongoing blurring of the spheres (public and private, domestic and global).

The term corruption is not a term of criminal law, but a sociological one. Corruption is a shorthand
reference for a range of illicit or illegal activities. Corruption is, in short, the abuse of authority (be
it granted in the public sphere or in the private sphere) for private purposes. Originally, the term
corruption was used to designate the abuse of public authority. Along that line, a definition by
Transparency International, the leading NGO in the global anti-corruption effort, is: 'Corruption
involves behavior on the part of officials in the public sector, whether politicians or civil servants,
in which they improperly and unlawfully enrich themselves and/or those close to them, or induce
other to do so, by misusing the position in which they are placed.'
Since the 1990s, the concept of corruption has been extended to the private sphere. Notably the
Council of Europe's Civil Law Convention on Corruption defines 'corruption' as including the
private sector, in the following terms: "'Corruption" means requesting, offering, giving or accepting,
directly or indirectly, a bribe or any other undue advantage or prospect thereof, which distorts the
proper performance of any duty or behavior required of the recipient of the bribe, the undue
advantage or the prospect thereof. Also the United Nations Convention against Corruption
(UNCAC) of 2003 regulates corruption both in the public and in the private sector.

UNCAC lists the prevention of conflict of interest as one of the 'preventive measures' to combat
corruption. With regard to public officials, the Convention foresees the adoption of codes of
conduct, as 'measures and systems requiring public officials to make declarations to appropriate
authorities regarding, inter alia, their outside activities, employment, investment, assets and
substantial gifts or benefits from which a conflict of interest may result with respect to their function
as public officials.

With regard to the private sector, the Convention suggests to state parties the development of
standards and procedures designed to safeguard the integrity of relevant private entities,
including codes of conduct for ... the prevention of conflicts of interest. Anti-corruption measures
may include 'preventing conflicts of interest by imposing restrictions, as appropriate and for a
reasonable period of time, on the professional activities of former public officials or on the
employment of public officials by the private sector after their resignation or retirement, where
such activities or employment relate directly to functions held or supervised by those public
officials during their tenure.

Corruption has been acknowledged as one of the most important obstacles to sustainable
development and the rule of law. For example, both Council of Europe Conventions on Corruption
emphasize 'that corruption represents a major threat to the rule of law, democracy, and human
rights, fairness and social justice, hinders economic development and endangers the proper
functioning of market economics'. Combating corruption is therefore a high priority of global
politics and governance, ultimately in the interest of global peace, the international rule of law,
prosperity, and human well-being. Preventing corruption must start by addressing the situations
favoring it, notably situations of conflict of interest.