The Type 1 Agencyproblem represents the owner-manager conflict explained by Jensen and Meckling(1976),who suggested that when management and ownership of a firm are separated,there exists a scenario where managers may make decisions that are in conflictwith the interests of shareholders as shareholders view maximising shareholdervalue as their interest while managers may identify job security or promotionas their main interests. For example, managers may undertake “self –dealing”, (i.e.
benefiting themselves by using company’s money for large transactions) or “empirebuilding” (i.e. incentive to run a bigger company since higher salary is quitecorresponded with firm size and prestige). To elaborate further, the type 1agency problem usually takes the spotlight when the shares of a company are sowidely dispersed, in which only a small fraction of ownership are in the handsof individuals or financial institutions, creating a scenario where eachindividual has to gather the support of other shareholders if any pressure onmanagement were to be effective in aligning interests. Without this separation ofmanagement and ownership, the Type 1 problem should not exist.
In the case of afamily company, since both ownership and control are in the hands of a familyCEO, there would be no conflict of interests and no alignment of interestswould have to occur. Hence, Jensen and Meckling (1976) have suggested using ashare-owning mechanism for managers to lessen the conflict between them andshareholders as both stakeholders would have the same incentive, which is toraise the share price in order to benefit from a gain.The type 1 agency problem differs from thetype 2 agency problem in the different stakeholder conflicts that occur. Whiletype 1 illustrates the conflict between owners and managers, Villalonga and Amit (2006) illustrates the type2 problem as a scenario where a “large shareholder may use its controllingposition to extract private benefits at the expense of small shareholders”.
Hence, the large shareholder can impose itswill on the management team. For example, they can vote against the board inthe annual general meeting, threatening to replace the whole board if they don’tdo their bidding or align company interests with theirs. The ownershipstructure of Lush company is a good illustration of the type 2 scenario, withMark Constantine and Margaret Constantine controlling most of the stakes with38.1% and 24.3% respectively. It should be noted though that depending on theidentity of the controlling shareholder, type 1 agency problem and type 2 canovershadow one another.
Villalonga and Amit (2006) states that if the largeshareholder is a financial institution, the dilution of shares may createsmaller incentives for it to expropriate minority shareholder’s interests, sotype 1 agency problem would probably occur, whereas if the shareholder is anindividual or family, then Agency problem 2 would most likely occur. (b) Judging solely from theownership information for Sainsbury PLC, I expect it to suffer from the type 1agency problem due to two factors: the non-existence of family management andthe diverse ownership of shares throughout the company. These would beexplained in accordance with the insights of Type 1 Agency problem in (a). Firstly, Sainsburyhas transformed from a family business to a firm whose stake is held mostly byoutside financial institutions. In theownership data report, Sainsbury has around 113 shareholders, in which 98 ofthem are from large outside firms that invested in the company via its funds inan attempt to hold diversified portfolios to satisfy their investors.
Since David Tylerand Michael Coupe took the position of chairman and CEO respectively, Sainsburyalready does not have a family management hierarchy as both members have noties with the family tree of Sainsbury, giving rise to the potential occurrenceof Agency problem 1. In (a), we have established that this occurs when thereare misalignments of interests between owners and managers. For example,Sainsbury once planned for a takeover bid of Home Retail Group but met strong oppositionfrom one of its shareholders, Qatar Investment Authority, who was disappointedby the fact that Sainsbury did not consult them for their opinion as theyrepresent the largest shareholder. Therefore, this misalignment of interestshows that Sainsbury is most likely going to suffer from Agency Problem 1 undera management environment where there is no family. Secondly, Sainsbury’sownership is evenly spread amongst these many institutional shareholders, with mostowners owning only about less than 4%, which ties in with our analysis on thecircumstances established for the type 1 agency problem.
Qatar InvestmentAuthority, being the largest shareholder, held 21.99% of shares in the companywith Credit Suisse Group AG coming behind at an amount of 11.15%. Otherinstitutions and individuals along the list of shareholders own less than 4% ofshares, including remaining members of the family.
In (a), we’ve alreadyestablished that type 1 agency problem might occur under this circumstancesince shareholders are not incentivized to monitor management as they feel thatthe percentage of their holdings are not great enough to influence managementdecisions and that collaboration with other shareholders is needed if anyinfluence is to have any effect. Carol Padgett (2011) gives another explanationbehind the thoughts of institutional managers. She asserts that some fundmanagers are reluctant to take an interventionist stance towards ownership dueto a possible corrosion in value of equity portfolios if it was found out thatthey were in dialogue with corporate management as the market mightmisinterpret this as company failure problems and bring down the share price,which would definitely affect their portfolio gains and put fund managers in aposition of being privy to inside information. (C) The UK CorporateGovernance Code is a guide to effective board practice that can deliver thelong-term success of a company which constitutes 5 components: Leadership,Effectiveness, Accountability, Remuneration and Relations with shareholders.This section aims to discuss the large extent in which the board structure ofSainsbury successfully complies with the principles of the UK corporategovernance Code and will also examine the implications of a lack of compliance withthe code on shareholders. Firstly, in terms of “Section A: leadership”, the UKgovernance code asserts that every company should have a sounding board that contributesto the long -term success of a company in alignment with their statutory duties,with a clear definition and differentiation of responsibilities of each boardmember.
David Alan Tyler, who is the present Chairman, has the innate competenciesto lead the board of Sainsbury, considering that he had broad and extensive experiencein chairman roles previously at Logica plc and 3! Quoted Private Equity plc. Therefore,he would be able to contribute to Sainsbury’s long-term success. Moreover, Inthe annual report, a clear definition of each of the committee’s and seniorlevel executive’s responsibilities were explained thoroughly, stating thatDavid would be responsible for the leadership of the board, Mike Coupe would beresponsible for day-to-day management of the business and Susan Rice would actas an intermediary between other Directors and Mike.
The titles of chairman andchief executive officer were also separated clearly in the annual report as anavoidance to high concentration of power in the hands of one executive.Secondly, in “SectionB: Effectiveness”, the UK governance code illustrates that the board should becomposed of the right set of knowledge and skill sets that would enableeffective discharge of statuary duties and responsibilities. Each board ofdirectors of Sainsbury had significant and relevant past experience that areconducive to their current title and responsibilities to contribute to thelong-term success of the firm. For example, Senior Independent Director SusanRice had previous experience in retail banking and financial services, havingassumed the role of managing director and chief executive of Lloyds bankinggroup Scotland and Lloyds TSB Scotland plc respectively. Therefore, her career experienceis particularly relevant to Sainsbury’s ownership of Sainsbury’s Bank. Moreover,a nomination committee is currently present in Sainsbury’s board structure toconduct rigorous and transparent procedures for the appointment of newdirectors, with most of its members being independent directors, hencecomplying with section B of the code. Thirdly, based on “Section C: Accountability”, the UKcorporate Governance Code dictates that the auditing board structure shouldconsist of at least three independent non-executive directors, along with therequirement that at least one member of the audit team acquired relevantfinancial experience prior to joining, which is imperative in order to persuadethe public and shareholders of the competency and expertise that the audit teampossess relevant to the business sector to which the company operates.
Inrelation to Sainsbury’s accountability section, the auditing board consists ofDavid Keens, Matt Brittin and Brian Cassin, who are all identified as independentnon-executive directors. According to Bloomberg, since David Keens possesses profoundfinancial experiences given his involvement with Next PLC as Group FinanceDirector and served as Group Treasurer with NEXT from 1986 to 1991, combinedwith his 7 years of management expertise in the accountancy profession, it can besaid that David Keens is a nice addition to the audit committee. Other auditingboard members also had significant experiences retail sector experiences.Therefore, as a whole, Sainsbury’s auditing board structure shows competency inits internal audit monitoring process and complies with the requirements of theUK Corporate Governance Code.
Fourthly, based on “Section D: Remuneration” of the UK CorporateGovernance Code, Sections D.2 suggests that the remuneration committee underthe board structure should implement a transparent and rigorous procedure forpolicy developments concerning remuneration at the executive level. Section D.2.1.elaborates further by suggesting that there should be a remuneration committeeconsisting of at least three independent non-executive directors, in which thechairman can also be considered a committee member if he or she was appointedas independent in the first place.
According to the remuneration report,Sainsbury’s remuneration committee during the year 2017 comprised of MaryHarris (Chairman), John McAdam, Susan Rice and Jean Tomlin, who are allclassified as independent non-executive directors. Moreover, the specific responsibilitiesand roles of the committee were all explained in detail, thus persuasive enoughto justify the authority delegated to the committee by the board. Hence, the remuneration committee’s boardstructure of Sainsbury has successfully complied with the recommended oneindicated in the UK Corporate Governance Code. Last but not least, in”Section E: Relations with stakeholders”, Section E.1and E.2 of the UK governance code respectively suggests that efficient dialogueshould take place between a company and its shareholders based on mutualunderstanding of company objectives and that general meetings are encouraged asa medium to communicate with them. Section E.
1.2, in particular, dictates that “the board shouldstate in the annual report the steps they have taken to ensure that the membersof the board…develop an understanding of the view of majorshareholders about the company”. In their annual report, Sainsbury hassuccessfully complied with this supporting principle by listing that the boardhad met with large investors and institutional shareholders through a number ofmediums, including presentations, invitation to stores and concessions, conferencecalls, road shows, etc. The content of these presentations and conferencemeetings were also posted on their website as to reach a wider group ofinvestors. Moreover, Important shareholder contact responsibilities were alsoclearly defined amongst the top executives, as Mike Coupe, Kevin O’ Byrne andJames Collins were the main points of contact for shareholders, with theChairman and Susan Rice (Senior Independent Director) attending to investormeetings regularly. Sainsbury also complied with Section E.2 as it held anannual general meeting to allow shareholders to meet and question the Board on5 July 2017.
It was stated in their annual report that all resolutions werepassed with majority voting based on a poll vote. The UK Corporate Governance Code is of great importance to shareholders becauseit allows them to identify Sainsbury as a trustworthy company that would align performancewith their own interests, which is to gain a return for lending capital to itin the first place. MacNeil and Xiao (2006) explains that some companies chooseto comply with the code due to the fact that the code represents the public andinstitutional investor’s view on the definition of best practice, and thereforemeans that a decision to comply would most likely improve a firm’s reputation,which would be reflected in its share price as price movement goes up,benefiting both the firm’s managers and shareholders as both sides get a gainin the shares they hold. In my view, lack of compliance to the code may causeshareholders to lose faith in the company and potentially fear that they maysuffer a huge loss. For example, a company that does not clearly outline itsboard responsibilities may cause shareholders to suspect that the board membersare not on the same page and do not share a similar vision for the long-termsuccess of the company. Or for example, if Sainsbury did not follow the rulesof Section C.3.
1, which as before, suggested that at least one member of theaudit committee have relevant financial experience, and employednon-independent directors that had no financial exposure, it might leadshareholders to be skeptical about the competency of the audit board to monitorits internal process, thus may give rise to “creative accounting” or “earningsmanagement”. Thus complying with the code is a means of maintaining publicconfidence and retaining shareholder’s interests.