The agency theory refers to the norms and principles that are used to explain the relationships between business principals and the agents. Considering the context of corporate governance, the agency theory manifests as essentially the accommodation of the interests of the principals and its stakeholders by the agents. The interrelationship between the agent and the principal along with the presence of the different incentives that encourage both correct and wrongful behaviour are crucial to a smooth flow of operations (Shi et al. 2017). The crux of the agency theory in terms of explaining corporate governance relates to creating an environment where the problems as well as the potential conflict areas between the principal and the agent are fundamentally eliminated over time.
Evaluating the case study, the preliminary agency problems can be identified when the then president of Enron’s trading operations Skilling decided to undertake the mark to market approach. The accounting method allowed Enron to overstate its profits by including sums that were yet to be received within the long term energy contracts. Furthermore, as argued by Jacoby (2020), the relationship between the company and its auditor, Arthur Anderson, is also a key projection of how agency problems manifest in the business environment. One of the largest auditing firms globally, Arthur Andersen agreed to prepare the accounts for Enron under the mark to market approach, thus keeping the shareholders in the dark regarding the actual profits of the company.
In order to understand how some of the mechanisms of corporate governance have been addressed and dealt with, it would be necessary to look into the Corporate Governance Council principles put forward by the Australian Securities Exchange. The first principle states that a solid foundation must be laid that inherently entail the aspect of oversight within the management. Furthermore, Principle 3 states that ethical and responsible decision making must be institutionalized at the very heart of the business (ASX Corporate Governance Council, 2019). Lastly, Principles 4 and 5 mention how integrity in financial reporting and timely and balanced disclosures are of paramount importance to ensuring corporate governance. Enron’s decision to implement the mark to market approach and initiate the large number of SPE’s to divert their funds was beyond any ethical justification. Moreover, the assistance provided by Arthur Andersen only complicated the problems further, albeit under pressure from the management.
Looking back in hindsight, the things that Enron managed to get wrong was the sheer disregard they had for the interests of their shareholders. The mark to market accounting method was certainly risky, and the management did not have a clear picture as to what the long term implications of the implications would be. Naturally, as the share price of Enron gradually began to fall, the company started dwindling under its debts. Regarded as ‘America’s most innovative company’, Enron filed for bankruptcy only six weeks after an estimated asset valuation of over $62 billion. There was an evident conflict of interest between the company and how it aimed to manage its shareholders along with its profitability, and this is largely what led to the Enron scandal, the gravity of which even led to new enactments and financial regulation laws. In terms of why the black box approach did not work, the key proposition relates to how future prices are considered to determine the valuation of an asset. It avoids any contingencies that may occur, which allows a company like Enron to grossly overstate its profits and pull in investments unethically.
The Satyam scandal is another major example of what poor corporate governance can lead to for companies in the long run. Considering the family history of the organisation, it could be inferred that the organisation would typically show a concentrated form of ownership. Ramalinga Raju, the then chairman and CEO of Satyam Computer Services, controlled the majority of the decision making power, thus putting the minority shareholders at an evident disadvantage. The stewardship theory of corporate governance would be the most applicable in this regard, where the management of Satyam took on the role of stewards to protect the interests of their shareholders. According to Keay (2017), the stewardship theory of corporate governance predominantly revolves around the stewards maximizing the wealth of the shareholders through performance of the organisation.
However, the company’s decision to acquire Maytas without any approval from the shareholders hints at the distinct lack of corporate ethics and a sound governance framework within Satyam. The company was also owned by the sons of the board’s chairman. It is important to discuss the concept of tunneling in this regard, where company transactions are engaged in with the objective of leveraging personal interests. The interests of the shareholders were essentially disregarded and made secondary, which eventually led to the scandal coming to the forefront involving over $1 billion and fraudulent fund transfers within the 300 odd family held firms under the Satyam group. In terms of the nature of the problem, the problems within Satyam primarily manifested as principal-principal problems, where the family shareholders went on to consistently bully the minority shareholders thorough financial dominance.
The stewardship theory would be the most apt theoretical underpinning related to corporate governance that would describe an ideal situation within Satyam. Under this theory, the executives act as stewards and tend to ensure profitability for the shareholders through organisational performance improvements. However, the practices within Satyam were rather on the contrary, where the executives seemed to consistently leverage personal interests. As stated by Bhasin (2016), sequestration of millions of dollars was engaged in by the company executives, and the funds were distributed fraudulently between the various family owned companies of the Satyam group. Another major issue that could be identified was the clear conflict of interests between the directors, which even led to four of the independent directors resigning over the acquisition of Maytas. Raju was essentially trying to hide funds in subsidiaries while showing their operations as independent from that of Satyam. It is one of the cornerstones of unethical practices within the agency theory, and the closing of the scandal certainly hints at the same.
ASX Corporate Governance Council. (2020). Corporate Governance Principles and Recommendations. Retrieved 22 June 2020, from https://www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf
Bhasin, M. L. (2016). Debacle of Satyam Computers Limited: A Case Study of India’s Enron. Wulfenia Journal, 23 (3), 124-162.
Jacoby, S. M. (2020). Executive Pay and Labor’s Shares: Unions and Corporate Governance from Enron to Dodd-Frank. Accounting, Economics, and Law: A Convivium, 1(ahead-of-print).
Keay, A. (2017). Stewardship theory: is board accountability necessary?. International Journal of Law and Management.
Shi, W., Connelly, B. L., & Hoskisson, R. E. (2017). External corporate governance and financial fraud: Cognitive evaluation theory insights on agency theory prescriptions. Strategic Management Journal, 38(6), 1268-1286.
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