Agency costs and ownership structure Essay Example | Topics and Well Written Essays - 2750 words

Agency costs and ownership structure - Essay Example A firm is a team effort involving several players - the owners, managers, shareholders, and lenders - that should work together to maximise the value of the firm in terms of profitability, sustainability, and performance. Recent experience, however, in the wake of business bankruptcies and scandals show that this team effort is not achieved in several cases. This paper reviews the available literature on the effects of family ownership, public ownership, and the dispersal of ownership on firm performance and value and provides a summary of the status of our knowledge of these relationships. Agency theory explores the effects of ownership structure on the performance of the firm. The theory states that the value of a firm will depend on the extent to which the interests of principals (owners) and agents (managers) are aligned. However, the interests of the principals are not the same as the interests of the agents, so aligning the two sets of interests will incur so-called agency costs. In this paper, we review the available literature on the application of agency theory in two types of ownership structures. First, we looked at firms that are majority owned, managed, or controlled by a single family and explored whether the aligned interests resulted in lower agency costs and better firm performance. In general, research findings supported the predictions of agency theory: firms where the founder-CEO, or a CEO-heir after the second generation, plays an active management role performed better than firms that are not dominated by a single family. ... cy cost that researchers term as "expropriation" have a negative effect on firm value as the dominant owners "expropriate" perquisites and other benefits to the detriment of minority owners. Second, we compared the performance of public and private firms. Research studies that included firms from a wide range of industries supported the agency theory, but the probability that results were influenced by factors that are endogenous to specific industries affect their external validity, or general applicability, to other industries. By looking at the results of a focused study using sample firms from one industry, we were able to establish the validity of agency theory in explaining firm performance. We also looked at the literature on the effects of a diversified ownership base on firm performance as reflected by stock price, with mixed results due to the effects of increased liquidity, rather than minimisation of agency costs, on improved firm performance. Introduction One of the most discussed topics in finance and economics is the ideal ownership structure that will maximise the value of the firm. This issue touches the core of why firms exist in the first place -to maximise profit for its owners - and explains partially how and why previously successful firms fail. Economists used to assume that everyone - owners, managers, employees, and lenders - act together for the good of the firm. After all, each one is bound by formal and informal contracts to ensure that firm value is maximised (Brealey and Myers, 1996, p. 991). This however seldom happens as there are conflicts of interest that affect firm performance, a phenomenon that academics have attempted to investigate over the last seventy years under the conceptual lens of ownership structure. How and why do