a) him by the project, a set
a) The role of financial manager is toact in the best interest of the shareholders when they take actions thatincrease the value of the company’s equity. In many large corporations,particularly in the United Kingdom, Ireland and US, ownership can be spreadover a huge number of shareholders. This dispersion of ownership means that noone shareholder will have enough power to influence management for theirinterest, suggesting that managers effectively control the firm. Hence this raisesthe question whether these managers will pursue their own goals or acting inthe best interest of the shareholders. This is what according to Villalonga and Amit (2006) type I agency problem. Type 1 agency problem is therelationship between shareholders and management (Investopedia, 2018). Such relationship exist whenever the principal hires theagent to represent their interest.
This is because you don’t have the skill to perform the taskand require someone to act for you. This problem occurs when the financialmanagers act in their own best interest rather than the shareholders’ wealth.For example, managers maygrow their firms to escape any acquisition attempt to ensure that their job issafe. However, a takeover may be in the shareholders’ best interest as thiswill bring them more wealth. Theproblem arises when the incentives of the principal and agent trying tomaximize their utility does not go align. Let’s say that you pay your roofer bythe hour. By doing so, the roofer realizes that by taking as much time aspossible, he could reap a higher reward in the form of money.
You are unable preventthis, as you know little about repairing a roof. Hence the problem. Althoughthe roofer has fixed your roof, you end up paying more. To prevent suchconflict, principal has to create a deal that satisfy both party. Turning backto the example of the roofer, let’s say that you change an element to theroofing contract like instead of paying the roofer by the hour, you pay him bythe project, a set fee. By doing this, you have eliminated the roofers incentive toextend the project. Eliminating the principal-agent problem comes down tofinding the conflict of incentives.
If you eliminate the conflict, youeliminate the problem. Besides that, existanother agency problem that is known as type II agency problem. This is therelationship between dominant shareholder and other shareholders who have asmall proportional ownership stake. Such a relationship exist whenever acompany has concentrated ownership structure, which is common in manycountries. When an investor owns a large percentage of a company’s shares, theyhave the ability to remove or install a board of directors through their votingpower.
This means that indirectly, they can make the firm’s objectives alignedto their own personal objectives, which may not be the same as that ofshareholders with a smaller proportionate stake. It may seem odd that one setof shareholders can have a different objective to a different set of shareholdersin the same company. Agency theory recognizes that everyone has a personalobjectives and these may not be congruent with other groups in an organisation. To differentiatebetween type I and type II, first and foremost we have to identify if there isa group of shareholders in the company that holds a majority share which isenough to influence the vote of the shareholders. If this is not the case, itis most likely for type I agency problem to occur instead.
b) Back in 1869, ayoung couple set up a small dairy shop in a small property they rented, no onecould have predicted that this would go on to become a nationwide retailer,known to families right across the country. This young couple were Mary AnnStaples, daughter of a dairy shop owner, and John James Sainsbury, son ofa craftsman from Lambeth. Their first shop is said to have opened on 20th April1869, the day they married. This was the beginning of J Sainsbury plc. J Sainsbury plc is a publiclimited company so the share can be bought by public through the stock exchange.
It is traded in the London Stock Exchange as SBRY. The top 5 shareholders areQatar Holding LLC, Credit Suisse Group, Blackrock Inc., BRANDES WorldwideHoldings LP and MAJEDIE Asset Management. Qatar Holding LLC is a privateequity firm specializing in strategic and direct investments in strategicprivate and public equity. It holds about 21.99% of the share in J Sainsburyplc, equivalent to 481,746,132 ordinary shares. On 16 April 2016, the Qatarsovereign wealth fund and private equity CVC have ended plans to launch adramatic takeover approach for the UK supermarket group J Sainsbury (TheTelegraph, 2016). It was understood that QatarInvestment Authority (QIA) to have joined forces with CVC Capital Partners andbrought in Brookfield group, which is a Canadian property specialist to launcha takeover bid for the grocer.
This was due to Sainsbury’s share that havefallen almost 25pc during the past two years which is a 12-year low. However,Sainsbury was able to struck a deal worth £1.4 billion to buy Argos owner, Home Retail Group. The HomeRetail board announced that it recommended to take the deal from Sainsbury, asthis will benefit both companies from the significant cost savings and betterrange of products and faster delivery networks for customers. Qatar Holdinginitially invested in Sainsbury through a vehicle called Delta Two. It built upits shareholding through a serious transactions in 2007 before launching atakeover bid worth 600p, or £10.6 billion. This bid eventually failed but Qatarstill retained a stake of 25.
1pc. Here we can clearly see thatSainsbury experienced a type I agency problem. This is because, while QatarHolding LLC planned on trying to takeover Sainsbury, the manager decided tostruck a deal that can save the company and secure their job instead. It is understood that citygrandee Archie Norman, who is currently chairman of ITV and made hisreputation as chairman of Asda, was identified as a potential chairman ofSainsbury’s. By avoiding the takeover, the chairman of Sainsbury, David AlanTyler was able to stay inposition. This was not the case for Qatar Holding LLC as they want to increasethe share of J Sainsbury plc instead for the wealth of shareholder. From thisscenario, the managers were the one that got the best outcome from the deal. Thisis totally different to a type II agency problem where there is a majorityshareholder that has enough power to influence the decision.
If that was thecase, Qatar Holding LLC would have successfully proceed the takeover andachieve its objective. c) Corporate governance is the system of rulesor practices and processes which a company is directed and controlled(Investopedia, 2018). It mainly involves balancing the interests of company’smany stakeholders such as shareholders, management and many more. Sincecorporate governance also provides the framework for attaining a company’sobjectives, it encompasses practically every area and part of management, fromaction plans and internal controls to performance measurement. In the UK, thereis a Financial Reporting Council (FRC) that is responsible for promoting highquality corporate governance and reporting to foster investment (FinancialReporting Council, 2018).
They are responsible of setting the UK CorporateGovernance Code, that is used to monitor and take action to promote the qualityof corporate reporting and auditing. There are five section to the code, whichare Leadership, Effectiveness, Accountability, Remuneration, and Relations withshareholders. Each section is important and relevant for a company to operateat its highest level.
First we’ll be talking aboutSection A, or also known as leadership. A company should be headed by aneffective board which is collectively responsible and aiming for the long-termsuccess of the company. The board’s role is to provide leadership of thecompany within the framework of effective controls which enables risk to bemanaged and prevent any unwanted outcome. The board are in charge of setting the company’s strategic aims andensuring that the necessary financial and human resources are in place to meetthe company’s objective. The board currently comprises three ExecutiveDirectors, the Chairman and six Non-Executive Directors.
J Sainsbury plc is ledby David Alan Tyler, who is a Non-Executive Independent Chairman of theboard since 1st November 2009. All of these members are skilled andexperience in the field hence able to provide the required leadership needed.They are elected by shareholders at the first Annual General Meeting (AGM)after their appointment and re-election at each AGM thereafter. Besidesthat, the second section of corporate governance code, or Section B, is effectiveness.The board and its committees should have the appropriate balance of skills,experience, independence and knowledge of the company to enable them todischarge their respective duties and responsibilities effectively. Alldirectors should be able to allocate sufficient time to the company todischarge their responsibilities effectively and successfully. Directors shouldreceive induction on joining the board and should regularly update and refreshtheir skills and knowledge. The board should be supplied in a timely mannerwith information in a form and of a quality appropriate to enable it to dischargeits duties.
The board also must undertake a formal and rigorous annualevaluation of its own performance and that of its committees and individualdirectors. The most important factor of the process is that, the board must beof an effective size or group. This is to ensure that the business can achieveits objective effectively without any disruption. Previously we have discussedhow the board consist of directors who are executive and non-executive. This providesan effective board that can ensure the company is operating smoothly andaccording to plan. Furthermore,Section C talks about accountability. The board are responsible in determiningthe nature and extent of the principal risks it is willing to take in achievingits strategic objectives.
They should maintain sound risk management andinternal control systems. They are also in charge of establishing anarrangements that will enable it to ensure the information is presented isfair, balanced and easily understand. This can be seen from J Sainsbury plcannual report, where everything is presented in an understandable manner andwell organised.
They include a content page to guide the users of the report sothey can get the information that they want easily. There, the user can eitherlook at information at Strategic Report, Governance Report and also Financial Statements. The directorsalso explained how it is their responsibility for preparing the annual reportand accounts and state how the whole thing taken is fair and balanced. Here wecan see that Sainsbury has prepared few reports such as Financial Reporting,External Audit, Internal Audit and many more. To confirm that the Annual Report and Financial Statements arefair and balanced, there is a year-end review process to ensure that theCommittee and the Board as a whole has access to all relevant information. SectionD is regarding remuneration.
Remuneration should be designed to promote thelong-term success of the company. Performance-related elements should betransparent, stretching and rigorously applied. There should be formal andtransparent procedure for developing policy on executive remuneration and forfixing the remuneration packages of individual directors.
The remunerationcommittee should judge where to position their company relative to othercompanies. But they should use such comparisons with caution, in view of therisk of an upward ratchet of remuneration levels with no correspondingimprovement in corporate and individual performance and should avoid payingmore than is necessary. In order to create the remuneration, there must be aformal and transparent procedure for developing policy on executiveremuneration and for fixing the remuneration packages of individual directors.
No director should be involved deciding his or her own remuneration. Sainsburyannual report contains the summary of the remuneration decisions, such asSalary, Annual Bonus, Deferred Share Award and many more. Finally,the last section of corporate governance code is the relations withshareholders. There should be a dialogue with shareholders based on the mutualunderstanding of objectives. The board as a whole has the responsibility ofensuring that there is a satisfactory dialogue with the shareholder. After all,the shareholders are the owner of the company. The board should use generalmeetings to communicate with investors and to encourage participation from themsuch as listening to their ideas and making sure that they are satisfied withthe return that they are getting. From Sainsbury’s annual report, we are ableto see that Shareholders had the opportunity to meet and question the Board atthe AGM.
There was a display of various aspects of the Company’s activities.All resolutions proposed at the 2016 AGM were taken on a poll vote and werepassed with significant majorities. Here we can clearly see that JSainsbury plc complies with all of UK Corporate Governance Code.
Lack ofcompliance may become a problem becausethe code acts as a frame for shareholder to understand the operation of thecompany and ensuring that their wealth is taken care of. For individualshareholders, it is best for them to invest in a company that follows all ofthe code so that they would understand the operation better. After all, one ofthe purpose is to provide transparency.