Management and Accounting

 THE BOARD OF DIRECTORS

It is needed to make sure that who is running the business is doing it to

meet the shareholders expectations.

If there is not the board of directors, shareholders are not involved in the jobs, and

in this way managers can run the business according to their own interests, which is

not always the same of the shareholders. Xes. a manager has specific aims (to

maximise sales and to have an high remuneration):

getting the most they can from their remuneration, if the managers are paid

 the amount of salary plus a percentage on sales, they try to maximise the

sales. So as to do so, managers could opt for cutting costs and in this way the

price could get lower and so maybe the sales could be more. However, cutting

the cost would bring a worse quality and in the long run the business could

have less sales because of the lack of high qualitymaximise their

remuneration in the short term to have a higher salary (manager’s turn out is

really fast and so they want to make the best out of their short-term contract).

Moreover, they will be more attractive in the job market (because of the

 increasing number of sales), they can go away and change their job before the

consequences of their choices can be discovered and punished by the

business. The manager is going to appear profitable to the other businesses

since he was able to maximise the sales, (some companies are not going to

find out the fact that the manager had cut costs, that’s because a lowering in

the sales will occur in the long term).

In this case the manager is not working following the need and desire of the

shareholder’ (unless the shareholders are speculating - they want a high income in

the short term and sell their share rapidly and they are interested in short term

results).

When the managers do their interests there is a situation that is called the principal-

agent problem. THE PRINCIPAL-AGENT PROBLEM

This topic explains most of the problems in a corporation, the principal-agent problem is

a conflict between owners and managers and occurs when managers (agent) pursue

their own interests rather than maximising shareholders’ (principal) value.

Xes. Real life: 2008 Financial Crisisbank executives took excessive risks for short-term

bonuses, while shareholders and taxpayers bore the losses.

The principal-agent problem is a conflict between two parties:

principals, they are the shareholders in this case, so the party that is

o providing the other party with capital.

agent, is the one acting on behalf of the shareholders (the managers),

o they are chosen and provided with compensation by the shareholders

who are not involved in the daily activities of the business. The agents

(managers) are working in the company but they are not the owners of

the company, they expect to be compensated for their job, this happens

when the company is a legal entity which is separated from the owner

(corporation) so it’s also listed as a public company, and the

shareholders are not working as managers.

The public corporation is the environment in which the ‘principal-agent’ problem

occurs, so when the managers are not the owners of the business and somehow,

they could follow their interest and not the one of the company, this rises two kinds

of problems:

1) The agent is supposed to work on behalf of the owner and to provide effort,

time and abilities to their job. The conflict occurs when the managers are

working on behalf of the owners but they are pursuing a different interest than

the interest of the owners so there is a problem of interest here, which is

Conflict of Interest

called the . information asymmetry

2) The other problem is when there is a sort of ,

one of the two parties knows more or knows less, the party of the agents

has more information than the principal. Therefore, the information

asymmetry means that the agents have

more information than the principals

and can use this information in pursuing

their own interest. The agents know

everything and the principals do not

have the same information of the

agents and this conflict generates the

Adverse Selection and the Moral

Hazard.

So given the principal-agent relationship: the

principal hires the agent, compensate the

agent who is expected to follow the interests

of the owner but there could be a gap, the information asymmetry and there

can be pathological situations where moral hazard occurs.

-Moral hazard: occurs after a transaction when one party takes undue risks

because another bears the cost. Xes. The cutting of cost and the lowering of

the quality because managers are not bearing the risk, they do not care about

the sells.

The manager who decided to cut the cost takes one risk, however he does not

know what consequence will be (it could be a lowering quality that is still

acceptable for the customers or not).

moral hazard means taking a risk because another bears the risk and not

so

knowing the result of that risk. The manager does not care about these risks

because he is not bearing the cost.

-Adverse Selection: this happens before the transaction occurs. Xes. I want

to invest, since an investor do not know who the managers of its potential

investing company are, even how they are being compensated. The

information asymmetry generates the adverse selection, with not knowing

everything, an investor could choose wrongly. The shareholder expectations

can be different If an investor wants to have fast income in the short-term, he

will use a business which has a percentage on the selling for the manager,

while if an investor wants a long-term investment, he will choose the business

whose compensations are for the long-term.

Mitigation: Mitigation refers to the set of mechanisms used to reduce

agency problems and information asymmetry between principals

(shareholders) and agents (managers).

It aims to ensure that managers act in the best interests of shareholders rather

than pursuing their own personal goals. This can be achieved

through monitoring activities, disclosure requirements, and incentive

contracts that align managerial behavior with company objectives.

Remuneration: the top mangers’ remuneration is an information that is

mandatory requested for listed companies and they have to write it in the

annual report, and it is decided by the authorities overseeing the capital

market. Providing that piece of information on how are you compensating the

managers, is fundamental in market.

Xes. Ferrari: you can know the remuneration, that is because the authority is

requiring those companies to provide that breached of information in the

annual report.

The conflict of interest: the annual report, and all the kind of information

which are required, are aimed at filling the information asymmetry, if the

authority (SCC) is requiring that company to mandatory provide that piece of

information, the result is that the information gap has been refilled and that

information is not hidden anymore because they provided it.

Why are the authorities asking companies to do so and to give information?

The aim is solving the information asymmetry problem. Corporate governance

is a way to make company accountable for how they govern their decisions and

the ones who avoid providing information, are punished.

This is a way to protect investors in filling the information asymmetry and to

solve the agency problem between principal and agent.

Transparencythey want the investors and shareholders to be aware of what

is a happening in the black-box (company) and through the annual report it

becomes transparent. In other words, governance reduce risk, lowers cost of

capital, and improves long-term performance. If all the companies are

supposed to follow the same rules, all of them are required the same piece of

information, the investors know the risks and also the expectations they could

have and they decide where to allocate capital.

The rules that are nowadays in place, are the result of an evolution, the result

of big scandalous which generated big consequences: investors losing money.

Authorities tried to solve the problem, requiring information and setting new

rules with Corporate Governance.

AGENCY THEORY

According to the Agency Theory, the company is a nexus of contract among

individuals who are claiming different interests, (the shareholders, customers,

suppliers and etc), so it involves all the people who claim something from the

business, the stakeholders. Also, among these relationships,

the contract between managers and shareholders includes mechanisms that are

aimed at making the managers work better and follow the interests of the company.

One decision can be how to pay the manager, so that he will behave in alignment

with the company itself, so that they have the same aim of the shareholders.

Every part of the business is bound together by a contract and each one of them can

be different according to the kind of individuals it has to bond.

To reduce opportunistic behaviour and motivate managers to act in line with the

company objectives, they use incentive design: stocks options, performance-based

bonuses, and career incentives reduce opportunistic behaviour.

Conflict resolution: agency conflicts can be mitigated through legal contracts,

incentives and governance mechanisms to align managers’ interests with

shareholders’. The contract is different for every business, based on the goal the

business hasXes. If the company has the goal to minimize the carbon emission,

there would be a contract that convince managers to behave in a certain way so

that the remuneration will be aligned with that goal in terms of rewarding, (If you will

be able to reduce the emission, i will give you 2% of compensation, the less the

emission the more you will be paid).

The contract is made among the parties to prevent and to solve the conflict.

THE ROLE AND STRUCTURE OF THE BOARD OF DIRECTORS:

The board of directors is essential to make business occurs and even to decide how

to managers are going to work, so is the main deciding point. The directors sitting

around the table are people nominated by the shareholders, during the general

assemble (are trusted people), and are indicated by the governance rules what is

going to decide and in which case they must report their decision to the

shareholders, and when they are not supposed to do so.

The board of directors is in charge of governing and controlling on behalf of the

shareholders. Xes. the annual report is the main document that is used to make the

shareholders (and actually possible investors) aware of the situation of the business

(how the business is going, the remuneration of the managers...). It is mandatory to

give the annual report to the shareholders, actually it is mandatory to share the

reports not only annually but also during the year.

The board of directors is the main body that is acting, setting the rules, taking

decision and reporting to the sharehold