Diritto commerciale II Paola Lucantoni Professore associato di Diritto dei mercati finanziari Università degli Studi di Roma “Tor Vergata”

AGENCY PROBLEMS OR PRINCIPAL-AGENT PROBLEMS An agency problem arises whenever one party, termed principal, relies upon actions taken by another party, termed agent, which will affect the principal’s welfare. The problem lies in motivating the agent to act in the principal’s interest rather then simply in the agent’s own interest.

Agency costs in business firms Firm’s owner and managers Majority shareholders and minority shareholders Firm and stakeholders

Firm’s owner and managers Managers – agents Firm’s owner – principal Legal problem: assuring that the managers are responsive to the owners’ interests rather than pursuing their own personal interests.

Majority shareholders and minority shareholders Controlling shareholders – agents Non controlling shareholders – principal Tension when controlling shareholders can take decisions affecting the class of owners as a whole Similar agency problems: between ordinary and preference shareholders; between senior and junior creditors in bankruptcy

Firm and stakeholders Firm itself – agents Creditors, employees, customers – principal So called externalities

Legal strategies for reducing agency costs prescriptive They dictate substantive terms that govern the content of the principal- agent relationship, tending to constrain the agent’s behavior directly Regulatory strategies They seek to facilitate the principal’s control over their agent’s behaviour Their efficacy depends on the ability of the principals to exercise their control rights Governance strategies

1. Regulatory strategies: Rules and standards to regulate the substance of agency relationship Rules: prescribe specific behaviours ex ante; commonly used in the corporate context to protect a corporation’s creditors and public investors. Creditor protection rules such as; dividend restrictions; minimum capitalization requirements; rules requiring action to be taken following serious loss of capital.

1.Regulatory strategies: Rules and standards to regulate the substance of agency relationship Standards: leave discretion for adjudicators to determine ex post whether violations have occurred Good faith, fairness

2. Regulatory strategies: Setting the terms of entry and exit Regulating the terms on which principals affiliate with agents rather than , as with rules and standards, regulating the actions of agents after the principal – agent relationship is established.

2. Regulatory strategies: Setting the terms of entry and exit Entry strategy: requiring agents to disclose information about likely quality of their performance before contracting with principals. Important in screening out opportunistic agents in the public capital markets. IPOs

2. Regulatory strategies: Setting the terms of entry and exit Exit strategy: allows principals to escape opportunistic agents. The right to withdrawal The right to transfer

3. Regulatory strategies: Trusteeship and reward Trusteeship strategies: seeks to remove conflicts of interests ex ante to ensure that an agent will not obtain personal gain from disserving his principal. It does not define what the agent can do, but rather what he can’t do. Independent directors Auditors

2. Regulatory strategies: Setting the terms of entry and exit Reward strategies: rewards agents for successfully advancing the interests of their principals. Sharing rule that motivates loyalty by tying the agent’s monetary returns directly to those of the principal. i.e.: equal treatment when tender offers. Pay-for-performance regime: the agent, although not sharing in his principal’s returns, is nonetheless paid for successfully advancing his interests. i.e.: stock options

Other strategies Selection and removal - corporate governance: Appointment rights: the power to select or remove directors. Initiation and ratification: Decisions rights with grants principals the power to initiate or ratify management decisions. Disclosure: