Agency Problem in SOEs of China

Agency problem is a worldwide problem wherever it is in western countries or China. It is inevitable during the development of the firm†s organization. As long as the interests between the owner and management are not aligned, the conflict is existed. Many western firms have established the rules and incentive systems to prevent â€Å"agency problem†. Somehow it works. We find it is not enough to overcome the problem. China has undergone a long period economic reform. During the reform, how to improve the SOEs performance is a hot focus. In the past, all the SOEs were controlled by the government, what the companies† doing were decided by the government, then on one side the executives did not take the full responsibility for the company; on the other side, the officer blamed the managers for the bad performance. There are no clear boundary on the space of freedom and responsibilities. (see Georges Enderle) The â€Å"agency problem† became even worse because of this phenomenon. Now China has tried a lot of methods to establish the modern organization of SOEs. The boundary between the government and the executives of SOEs has been clearly set. Some SOES have been published. However we find that the â€Å"agency problem† still exist more or less and the business ethics do be involved. And business ethics can play a virtually important role in dealing with the â€Å"agency problem during the economic reform. 2. Definition of † agency problem† Before we go further, we need to define what is agent and what is agency problem. Agent is the entity where Management represents owners; the agency relationship is the relationship between the principal and the agent, in which the agency acts for the principal. And what is agency problem? The agency problem results from the separation of management and the ownership of the firm. Agency problem can be clarified as the followings: Agents may consume excessive perks. Agents may shirk (not expend their best efforts). Agents may act in their best interest (instead of the interest of the principal). 3. Why does â€Å"Agency Problem† happen? On the very beginning, most firms were based on the family and their management was the members within the family, and there was not agency problem at all, because the management and ownership were aligned, no interest conflict. As the firms grow, it seems they need high management skills and the existed relationship within the management restricted the growth of the firms. Furthermore, it was much more difficult to raise new equity. Then they hired the professional managers to act as the owners. The agency problem is followed as this organization comes out. Due to the interest is not alignment between the managers and the owners, more or less the managers will pursuit their own profit instead of the owners, which we thought is unethical because of the space of freedom and responsibility are not matched. (see Georges Enderle) and we will discuss later. Although the goal of the firm is the maximization of shareholder†s wealth, in reality the agency problem may interfere with the implementation of this goal. The agency problem results from the separation of management and the ownership of the firm. For example, a firm maybe runs by the professional managers who have little or no ownership in the firm. Because of this separation of the decision-makers and owners, managers may make decisions that are not in line with the goal of maximization of shareholder wealth. They may approach work less energetically and attempt to benefit themselves in terms of salary and perquisites at the expense of shareholders. The cost of â€Å"Agency problem† is obvious. There are the monitoring costs, bonding costs and the residual loss. Monitoring costs are costs incurred by the principle to monitor the actions of the agents (Ex. Annual report to shareholders). Bonding costs are costs incurred by the agent to ensure they will act in the best interests of the principals (binding employment contract). The residual loss is the implicit cost when management and shareholders† interests cannot be aligned, even when bonding and monitoring costs are incurred. We will spend considerable time in monitoring managers and trying to align their interests with shareholders. Managers can be monitored by auditing financial statements and bonded by managers† compensation packages. The interests of managers and shareholders can be aligned by establishing management stock options, bonuses, and perquisites that are directly tired to how closely their decisions coincide with the interest of shareholders. The agency problem will persist unless an incentive structures set up that aligns the interests of managers and shareholders. In other words, what is good for shareholders must also be good for managers. If that is not the case, managers will make decisions in their best interest rather than maximizing shareholder wealth. 4. Does incentives or regulations eliminate the † Agency Problem†? A high level of compensation can result from a pay-for-performance system in which the executive has performed extremely well, or it can be the result of the agency problem, Where the executive is taking advantage of the system. Keep in mind that an executive compensation committee, appointed by the firm†s board of directors, generally recommends the CEO†s compensation package. Also keep in mind the board of directors, although elected by the shareholders, is generally nominated for election by the CEO and thus may be more sympathetic to the CEO†s desires than to the shareholders† best interests. This opens the door for † good old boy† networks to take care of their own and set up a compensation package that rewards, regardless of performance, without attempting to align managers† and shareholders† interests. So it is essential to establish a good controlling and monitoring system, but since it does not work so well or we have not find a perfect mechanical system to prevent it up to now. How should we do then? It is the ethical behavior that † doing the right thing†. A difficulty arises, however, in attempting to define â€Å"doing the right thing†. The problem is that each of us has his or her own set of values, which forms the basis for our personal judgments about what is the right thing to do. Every society adopts a set of rules or laws that prescribe what it believes to be † doing the right thing.† In a sense, we can think of laws as a set of rules that reflect the values of the society as a whole, as they have evolved. However, not all the â€Å"agency problem† has been against the law. As the individuals, they have a right to disagree about what constitutes â€Å"doing the right thing† and we will seldom venture beyond the basic notion that ethical conduct involves abiding by society†s rules. And some of the ethical dilemmas that have arisen with regard to the † agency problem†. These dilemmas generally arise when some individual behavior is ground to be at odds with the wishes of a large portion of the population, even though the behavior is not prohibited within law. Ethical dilemmas can therefore provide a catalyst for discussion. † Is ethics really relevant?† the answer is â€Å"Yes.† First, although business errors can be forgiven, ethical errors tend to end careers and terminate future opportunities. Because unethical behavior eliminates trust, and without trust businesses can not interact. Second, the most damaging event a business can experience is a loss of the public†s confidence in its ethical standards. 5. The agency problems in SOES do involve business ethics dimension. By the definition of the â€Å"agency problem† in the SOEs in China, the managers assigned or appointed are the agents, who manage the assets of the principal.(the country) They have a lot of authorities regarding personnel, funds and fixed assets etc., but they don†t have the corresponding responsibilities. The situation is a result of the mismatch of the space of freedom and responsibility as indicated by Georges Enderle. According to what Prof. Georges Enderle said, the space of freedom and responsibility should match with each other. On one hand, it is unfair for someone to be held responsible for something if he or she doesn†t have the freedom to make decision on it. On the other hand, it will be dangerous for someone to only enjoy the space of freedom without any or less constraints or responsibility. Sooner or later, he or she will abuse the authority to achieve for his or her own interests by hurting others. During the reform of the SOEs organization, the managers are granted with even more authorities for them to better manage their companies. But unfortunately, some managers undertake some unethical or even illegal activities to act against their companies and the country, which has caused a huge loss for our country. It was reported that total lost assets of the country amounted to about RMB 50 billion to 100 billion during the 1990†³s. The main reasons are that the managers of the SOES take advantages of their prevailed positions to gain personal interests for themselves. But they don†t really worry about the loss because they will not be responsible for that. Please read the following case: XXX Company is one of the largest SOES in Guizhou Province. Started from the 1980†³s, the company went into a very difficult situation, making a greater loss every year. Oct. 27, 1999, an extremely shocking news exploded the company: Guifang Jing, the 54-year old, female financial manager were involved in corruption of over RMB7 million. Very soon, she confessed that it was she that took advantage of her position and her professional knowledge to manipulate the financial statements and embezzle the company†s assets. At the beginning, she got involved in the bank accounts transaction directly by using as excuse that the cashier was not familiar with it. She hid 325 bank accounts in total, which amounted to RMB 57 billion in total. At the meantime, she played a lot of tricks in distorting the bank checks and gained RMB12 billion in total. After she embezzled so much money, she started to have an abnormal mentality. One time, when she found that the company still had some cash balance in the bank, she felt very sorry for not having taking out for herself†¦. One day when she was on the business trip, one financial clerk of the company found that one bank check of several ten thousand RMB was missing and he reported to the general manager and the latter reported to the police. Guifang Jing smelt that the police would start investigate very soon. After pondering over for several nights, she eventually recovered her conscience and decided to give herself to the police. Let†s analyze the case. It is true that she broke the law. But if her business ethics had been good enough, she would have not got involved in such illegal and unethical behavior. She was assigned and trusted by the shareholder to have the authority to manage the company assets, but she betrayed her company by abusing her space of freedom, especially when the company was in such a difficult situation. At that time she should have used her professional knowledge and cooperated with her colleagues to improve the financial performance of the company. Another reason was that there was no healthy corporate culture in the company. Employees were not encouraged and rewarded for making contributions to the company. So nobody really cared about the company. That kind of environment gave Guifang Jing opportunities to corrupt such a great amount of money. Upon knowing that the police would investigate the missing bank check, she decided to confess to the police to avoid more serious punishment. Actually, she was at the first stage of Konhlber-Inspired Typology of Ethical Dilemmas. If she had been in a higher stage, for instance, Stage 4 Conform to rules, laws, code, and conventions, or even higher, Stage 5 Follow principles based on respect for people and their rights, she would have not got involved to this crime. But we must be clear that the case of Guifang Jing was only one of the similar cases that happened in the SOEs in the country. Obviously the companies and the whole country need to take action to improve the business ethics, to foster a good and ethical business environment. So far, we have understood why the incentives and regulations cannot and will not solve the agency problems. The agency problems do involve business ethics dimension. Then there is a base for business ethics to play an important role in dealing with the agency problems. As common sense, human acquires knowledge through education, formal or informal. Without education (in a broad sense), people cannot understand the nature and the society. They won†t have their values developed in the process of learning and practice. Of course, they won†t act according to the social behavior orders and norms. Business ethics aims to discuss the business conduct/activities that raise moral issues and to improve â€Å"the ethical quality of decision-making process at all levels†: micro-, meso-, and macro-level (Enderle) through education.