‘Agency theory’ is an economic theory that drives a whole lot of thinking about corporations today.
At the heart of this prevailing authority is the idea that the board is the ‘agent’ of the collective shareholders or members in a not‑for‑profit. The shareholder or members are in this thinking the collective ‘principal’ for the company. The theory continues on that the board’s role is to strive to ‘minimise the cost of agency’ – to ensure that the cost of running the business is kept as low as possible so as to return maximum value to the shareholder; or in the case of the NFP to deliver on behalf of the members, maximum value to the beneficiaries of the organisation’s services.
Thought of against the reality of the way corporations work today, this agency theory mindset is at odds with that reality to say the least.
For a start the idea of the shareholders or members as the collective ‘principal’ is an odd notion in itself. After all, underpinning the usual concept of ‘principal and agent’ is the idea that the principal ‘calls the shots’. The principal can for instance usually withdraw the authority of the agent at any time. This is not the case in most corporations, except for the quite limited cases of:
- A venture capitalist investor with a majority stake in the company
- Dominant institutional investors in the context large listed corporations
- The founder/controller shareholder in a private company
Indeed very rarely can shareholders or members ‘withdraw’ the authority of the board (e.g. by removal of directors) without instigating a very long, slow, difficult process (which is costly to the company and therefore ultimately the shareholders anyway!). Sure, the unhappy shareholder can sell their shares – except of course in the predominant category of cases where the company is private and there is no market for the shares – or the member can resign membership. But in any case it is hardly a case of a collective principal with the ultimate authority ‘calling the shots’ with the agent.
The idea of the shareholders as the ultimate authority also is at odds with the constant refrain that directors hear and share all the time – ‘we are about the long term; management is about today’. And yet the current collective of today’s shareholders have no interest in tomorrow’s shareholders. Only their own investment imperatives and this often drives boards to say one thing (‘we are about the long term’) but to do another (‘we must ensure a good share price today’).
Agency theory also works particularly uneasily in relation to not‑for‑profit companies or organisations. For instance some NFPs exist to provide services to and for their members (e.g. member mutuals, peak industry bodies etc) but many have members who are not even the recipients of the services they provide (e.g. true charities with ‘supporters’ who are not the target people in need). The idea that the collective of the members is the ‘principal’ on whose behalf the board as ‘agent’ strives to optimise the services of the organisation is fanciful to say the least. In 2016 many NFPs either struggle to aĀract paying members or, even more damning for the ‘agency theory’ view of the corporation, are restructuring to remove separate membership, making the board members one and the same as the ‘membership’ that votes for the board.
A theory of corporations emerged just prior to the turn of the century, by two American scholars, Blair and Stout, which proposed the idea of the board as the mediating hierarchy – mediating the hierarchy of interests of the many stakeholders of the company – as an alternative to the prevailing idea of agency theory. Blair and Stout observed that the board’s responsibility is not solely to deliver optimum value to the collective ‘shareholders’ or for the collective ‘members’ but to balance that imperative against and amongst a range of interests of other corporate stakeholders.
This argument is still strongly refuted by good old fashioned ‘agency theory’ purists.
Whilst academic arguments rage over the best ‘economic’ theory to describe the corporation, companies get on with reality. And in reality the ‘mediating hierarchy’ is a much more balanced way for boards to think about themselves. After all, cases like that of the directors of James Hardie Industries tells us that clearly the responsibility of the board is not to optimise profit for shareholders at all costs. Rather it is to optimise profit, balanced against ensuring the interests of all stakeholders – or at least all key stakeholders – of the corporation are appropriately guarded and balanced. The challenge for directors then is to decide who those key stakeholders are and what their interests might demand, what is an ‘appropriate’ balance between them and so to then seek to balance them.
The company structure and the law of the land in Australia however still recognises the prevailing interest as that of the collective shareholders or members.
So the burning question I am trying to explore is this:
What do boards in 2016 regard as their responsibilities to no-shareholder/non-member stakeholders of the company? How does that play out in the boardroom?
Can you tell me?