Agency Conflicts and Corporate Governance

• Author: Praveen Kumar,Alessandro Zattoni
• Published date: 01 July 2017
• DOI: http://doi.org/10.1111/corg.12212
• Date: 01 July 2017

EDITORIAL

Agency Conflicts and Corporate Governance

The role of corporate governance (CG) in addressing agency conflicts is

of long‐standing interest. In their seminal work, Berle and Means

(1932) highlighted the agency conflicts between management and out-

side investors due to the separation of ownership and control and ini-

tiated the analysis of the efficacy of internal and external governance

mechanisms in addressing these conflicts. Subsequently, a long lit-

erature has considered the interaction of corporate governance

and agency conflicts (e.g., Hart, 1995; Jensen & Meckling, 1976;

Manne, 1965). The existing literature develops the multi‐dimen-

sional nature of agency conflicts among various internal and exter-

nal stakeholders of the firm and shows that no single corporate

governance mechanism solves these agency conflicts. For example,

agency conflicts can arise between controlling shareholders and out-

side investors (Aslan & Kumar, 2012, 2014; Kumar & Zattoni, 2015b),

or between various types of claimants on the firm's assets (Chava,

Kumar, & Warga, 2010; Zattoni, 2011), or between the management

and the board (Kumar & Sivaramakrishnan, 2008), and so forth.

Addressing these different types of agency conflicts typically

requires a combination of internal and external CG mechanisms, such

as incentive contracts and monitoring by independent boards, auditors,

and large outside investors (Kumar & Zattoni, 2015b). In addition, the role

of law and national‐level CG factors is also widely st udied in the CG liter-

ature (Kumar & Zattoni, 2013, 2016). Not surprisingly, the literature is far

fromsettled in developingour understanding of therelative effectiveness

of various types of CG mechanisms dealing with the myriad of agency

conflicts that exist within the firm. The literature continues to highlight

different types of agency risks that were not the focus of the early

agency literature. These include “tunneling”or diversion of resources by

dominant shareholders to other firms that they control; the effects of

ownership concentration on the design of debt contracts; and strategic

location of the firm by insiders to take advantage of tax benefits even

though thismay not be in the best interest of the stakeholders.

In addition, there is increasing interest in examining different types

of governance mechanisms to address agency conflicts. For example,

the recent CG literature examines the governance consequences of

activist external stakeholders (Aslan & Kumar, 2016; Brav, Jiang,

Partnoy, & Thomas, 2008), different aspects of executive incentive

and financial contracts (Kumar & Zattoni, 2016; Ward, Brown, &

Rodriguez, 2009), investor response to international cross‐listing of

firms (Kumar & Ramchand, 2008; Schiehll & Martins, 2016), controlling

owner location (Hoi & Robin, 2010), and national governance bundles

(Schiehll, Ahmadjian, & Filatotchev, 2014; Zattoni & Judge, 2012). The

novel types of agency conflicts and counteracting governance mecha-

nisms being considered in the literature indicates that this strand of the

CG literature is still growing and quite vigorous.

The four papers in this issue make significant contributions to the

CG literature by studying important and novel aspects of the interaction

of governance mechanisms with different types of agency conflicts. The

first paper by Zhang, Yang, Strange, and Zhang examines whether for-

eign institutional investors can moderate the agency risk from tunneling

by controlling shareholders in emerging markets. This is a very interest-

ing and important topic from both empirical and theoretical perspec-

tives. Empirically, tunneling by controlling shareholders in emerging

market economies is an important phenomenon (Jiang, Lee, & Yue,

2010; Johnson, La Porta, Lopez‐de‐Silanes, & Shleifer, 2000). Because

of the relatively weak firm‐and national‐level CG mechanisms in such

economies, the interplay of market and internal factors in governance

(Kumar & Zattoni, 2015a) would suggest that monitoring by foreign

institutional investors (FIIs) may moderate tunneling. However, FIIs

have their own objectives, which may not always lead them to control

tunneling. In particular, FIIs face a well‐known conflict between main-

taining control through external equity ownership and basing their trad-

ing activity on their private knowledge of firms; the latter may induce

FIIs to exit from the ownership of troubled companies, for example.

The effects of FIIs on tunneling agency risk is therefore empirically

unresolved in the existing literature and is of substantial interest. Using

a carefully collated but comprehensive dataset on FII activity in China,

Zhang et al. develop an interesting theoretical hypothesis on an

inverted‐U shape relationship between FII trading activity and the

extent of tunneling, which they then verify empirically.

In the second paper, Martins, Schiehll, and Terra examine the

effects of national‐level governance quality on the association

between equity ownership concentration and the maturity of the

firm's debt obligations. This is an important issue because debt

imposes “hard”disciplinary constraints on entrenched management

by legally obligating them to satisfy the firm's debt obligations (Hart

& Moore, 1995). Hence, short‐term debt along with large shareholder

ownership are often considered as governance mechanisms. But own-

ership concentration is itself influenced by national‐level governance

quality (Kumar & Zattoni, 2014; La Porta, Lopez‐de‐Silanes, Shleifer,

& Vishny, 1998). Martins et al. posit that long‐term debt and equity

ownership can act as substitutes (García‐Castro, Aguilera, & Ariño,

2013) in monitoring management but their relationship will depend

on the national governance quality. Testing this interesting hypothesis

requires inter‐country comparison, which has not been undertaken in

the existing literature. Using a comparative study of public firms in Bra-

zil and Chile, countries with a common legal origin and cultural similar-

ities, Martins et al. show that they differ significantly in six major

national‐level governance factors. The main finding of the study is that

relationship between equity ownership concentration and debt

DOI: 10.1111/corg.12212

220 © 2017 John Wiley & Sons Ltd Corp Govern Int Rev. 2017;25:220–221.wileyonlinelibrary.com/journal/corg