HomeChapter 3: Boards - Conflict Perspective3.2 A Conflict Perspective of Board Organization

3.2 A Conflict Perspective of Board Organization

The agency theory and other conflict perspectives of board organization principally focus on the diverging interests of shareholders and managers of publicly held corporations (Alchian and Demsetz, 1972; Jensen and Meckling, 1976; Fama, 1980; Fama and Jensen, 1983). Berle and Means (quoted in Mintzberg, 1983:35) already observed in the early 1930s that the ownership of large public corporations is so “ . . . widely distributed that no individual or small group has even a minority interest large enough to dominate the affairs of the company.” As a result, managers are free to maximize their interests that may not necessarily coincide with the interests of shareholders (Mulick, 1993). According to Hill and Jones (1992), stockholders act as wealth maximizers while managers seek to maximize a utility function that includes job security, power, remuneration and status. As indicated by Hoskisson and Turk (1990:462), “managers who pursue their own best interests may select different strategies than managers who pursue the interests of shareholders . . .”

Due to the separation of ownership from managerial control and differences in the utility functions of principals and agents, conflicts of interests can exist between shareholders and managers in public corporations. As such, a distribution or agency problem may occur in the exchange relationship between principals and agents in their roles of financiers, monitors and managers of listed corporations. According to Gedajlovic (1993:16), the “ . . . basic agency problem stems from the fact that the possessors of decision rights (managers) can adopt strategies or policies which negatively impact upon the wealth of residual claimants (shareholders).” This problem still has proven to be central to theories in the field of organizational economics (Wang, 1991). Although agency theory emphasizes that the separation of ownership from managerial control can be economically efficient, parties involved are also recognized to have different utility functions that may lead to conflicts of interests between owners and managers (Hoskisson and Turk, 1990).


The Model of Managerial Behavior

Jensen and Meckling (1976:308) define the principal-agent relationship as “ . . . a contract under which one or more persons (the principal(s)) engage another person (agent) to perform some services on their behalf which involves delegating some decision making authority to the agent.” These contracts include (in)formal agreements in which parties define contractual guarantees and obligations. Fama and Jensen (1983) indicate that agency problems can arise because contracts cannot be written and enforced costlessly. Shleifer and Vishny (1997:741) indicate that a contract “ . . . specifies exactly what the manager does in all states of the world, and how the profits are allocated. The trouble is, most future contingencies are hard to describe and foresee, and as a result, complete contracts are technologically infeasible.” The costs associated with contracts between principals and agents - the agency costs - “. . . include the costs of structuring, monitoring, and bonding a set of contracts among agents with conflicting interests.

Agency costs also include the value of output loss because the costs of full enforcement of contracts exceed the benefits” (Fama and Jensen, 1983:279). The design of contracts is complicated by perhaps the most uncertain factor in the relationship between principals and agents: the behavior of agents. Shleifer and Vishny (1997:737) state: “How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers?” As such, a conflict perspective of board organization assumes that agents cannot always be trusted to maximize the utility function of principals. Instead, it is assumed that managers will use their powers to pursue personal interests such as empire building, excessive remuneration, job security and other forms of self-interest orientation. Fundamental to this “model of man” is the assumption that individuals choose actions that maximize their welfare (Williamson, 1985; Maassen and van Montfort, 1997). Seen from this point of view, an agent is understood to be a rational single utility maximizer (Swedberg et al. 1990). This implies that every individual involved in the process of decision making recognizes self-interested motivations of other participants (Band, 1992).


The Corporate Board of Directors as a Mechanism to Alleviate Agency Problems

The agency theory treats managerial behavior as a potential source of opportunistic behavior unless this behavior is bounded by contracts, incentives and bonding mechanisms including the external threat of takeovers, competition in product-markets and competition in managerial labor markets. Agents can only be “trusted” after they have been put firmly under the control of principals with mechanisms that aim at the reduction of agency problems (Donaldson, 1990). Within the context of the agency theory, the corporate board of directors is seen as an important mechanism to alleviate agency problems in principal-agent relationships. According to Walsh and Seward (1990), the board of directors is responsible for the development and the implementation of internal control mechanisms that align the interests of management with the owners of the corporation. Fama (1980:294) sees the board as the ultimate internal monitor which “ . . . most important role is to scrutinize the highest decision-makers within the firm.“

Fama and Jensen (1983) also see the board of directors as a critical internal governance mechanism. According to these authors, “ . . . management and control functions are delegated by the residual claimants to the board. The board then delegates most decision management functions and many decision control functions to internal agents, but it retains ultimate control over internal agents – including the rights to ratify and monitor major policy initiatives and to hire, fire, and set the compensation of top level decision managers” (Fama and Jensen, 1983:287). The formation of corporate boards results to what Coleman (1990:162) calls a “complex authority structure.” This is an authority relation “ . . . in which there is both a transfer (from the prospective subordinate to the prospective superordinate) of the right to control and a transfer of the right to transfer that right of control to another (a lieutenant).” With the creation of such a complex authority structure, “ . . . a division of labor emerges in the management and control of organizational decision making. The managers initiate and implement their decisions, while the board ratifies them and, in general, monitors the conduct of the firm’s top managers” (Walsh and Seward, 1990:424). The next paragraph concentrates on the attributes of one-tier boards and the way these attributes facilitate the control roles of boards.

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Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.