The agency problem, agency cost and proposed solutions thereto : a South African perspective

Abstract

The development and growth of listed firms during the past few decades has caused an ever-widening gap between ownership and management. The agency theory addresses this relationship between owners (shareholders) and the custodians of their wealth, that is the management of a firm. If management's goals differ from those of the firm, an agency problem arises and the owners have to incur agency cost to overcome this problem. Besides discussing the theoretical principles underlying the above issues, an empirical investigation was undertaken, using questionnaires completed by firms listed on the Johannesburg Stock Exchange. It appears from the responses received as if the agency problem does exist in a significant number of companies. Shareholders at Annual General Meetings seem to concentrate more on statutory issues than on the goals of management. It is comforting, though, that directors must still approve key issues instrumental to the creation of economic wealth, such as the capital budget and financing decisions. The main methods employed by firms and their shareholders to overcome the agency problem are performance driven share and bonus schemes. It is proposed that a performance measure such as Economic Value Added can and should be used to overcome the agency problem to benefit both shareholders and management.