The the spotlight when the shares of a

The Type 1 Agency
problem 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 conflict
with the interests of shareholders as shareholders view maximising shareholder
value as their interest while managers may identify job security or promotion
as their main interests. For example, managers may undertake “self –dealing”, (i.e.
benefiting themselves by using company’s money for large transactions) or “empire
building” (i.e. incentive to run a bigger company since higher salary is quite
corresponded with firm size and prestige). To elaborate further, the type 1
agency problem usually takes the spotlight when the shares of a company are so
widely dispersed, in which only a small fraction of ownership are in the hands
of individuals or financial institutions, creating a scenario where each
individual has to gather the support of other shareholders if any pressure on
management were to be effective in aligning interests. Without this separation of
management and ownership, the Type 1 problem should not exist. In the case of a
family company, since both ownership and control are in the hands of a family
CEO, there would be no conflict of interests and no alignment of interests
would have to occur. Hence, Jensen and Meckling (1976) have suggested using a
share-owning mechanism for managers to lessen the conflict between them and
shareholders as both stakeholders would have the same incentive, which is to
raise the share price in order to benefit from a gain.

The type 1 agency problem differs from the
type 2 agency problem in the different stakeholder conflicts that occur. While
type 1 illustrates the conflict between owners and managers, Villalonga and Amit (2006) illustrates the type
2 problem as a scenario where a “large shareholder may use its controlling
position to extract private benefits at the expense of small shareholders”.  Hence, the large shareholder can impose its
will on the management team. For example, they can vote against the board in
the annual general meeting, threatening to replace the whole board if they don’t
do their bidding or align company interests with theirs. The ownership
structure of Lush company is a good illustration of the type 2 scenario, with
Mark Constantine and Margaret Constantine controlling most of the stakes with
38.1% and 24.3% respectively. It should be noted though that depending on the
identity of the controlling shareholder, type 1 agency problem and type 2 can
overshadow one another. Villalonga and Amit (2006) states that if the large
shareholder is a financial institution, the dilution of shares may create
smaller incentives for it to expropriate minority shareholder’s interests, so
type 1 agency problem would probably occur, whereas if the shareholder is an
individual or family, then Agency problem 2 would most likely occur.

 

(b)

 

Judging solely from the
ownership information for Sainsbury PLC, I expect it to suffer from the type 1
agency problem due to two factors: the non-existence of family management and
the diverse ownership of shares throughout the company. These would be
explained in accordance with the insights of Type 1 Agency problem in (a).

 

Firstly, Sainsbury
has transformed from a family business to a firm whose stake is held mostly by
outside financial institutions.  In the
ownership data report, Sainsbury has around 113 shareholders, in which 98 of
them are from large outside firms that invested in the company via its funds in
an attempt to hold diversified portfolios to satisfy their investors.

Since David Tyler
and Michael Coupe took the position of chairman and CEO respectively, Sainsbury
already does not have a family management hierarchy as both members have no
ties with the family tree of Sainsbury, giving rise to the potential occurrence
of Agency problem 1. In (a), we have established that this occurs when there
are misalignments of interests between owners and managers. For example,
Sainsbury once planned for a takeover bid of Home Retail Group but met strong opposition
from one of its shareholders, Qatar Investment Authority, who was disappointed
by the fact that Sainsbury did not consult them for their opinion as they
represent the largest shareholder. Therefore, this misalignment of interest
shows that Sainsbury is most likely going to suffer from Agency Problem 1 under
a management environment where there is no family.

 

Secondly, Sainsbury’s
ownership is evenly spread amongst these many institutional shareholders, with most
owners owning only about less than 4%, which ties in with our analysis on the
circumstances established for the type 1 agency problem. Qatar Investment
Authority, being the largest shareholder, held 21.99% of shares in the company
with Credit Suisse Group AG coming behind at an amount of 11.15%. Other
institutions and individuals along the list of shareholders own less than 4% of
shares, including remaining members of the family. In (a), we’ve already
established that type 1 agency problem might occur under this circumstance
since shareholders are not incentivized to monitor management as they feel that
the percentage of their holdings are not great enough to influence management
decisions and that collaboration with other shareholders is needed if any
influence is to have any effect. Carol Padgett (2011) gives another explanation
behind the thoughts of institutional managers. She asserts that some fund
managers are reluctant to take an interventionist stance towards ownership due
to a possible corrosion in value of equity portfolios if it was found out that
they were in dialogue with corporate management as the market might
misinterpret this as company failure problems and bring down the share price,
which would definitely affect their portfolio gains and put fund managers in a
position of being privy to inside information.

 

 

(C)  

 

The UK Corporate
Governance Code is a guide to effective board practice that can deliver the
long-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 of
Sainsbury successfully complies with the principles of the UK corporate
governance Code and will also examine the implications of a lack of compliance with
the code on shareholders.

 

Firstly, in terms of “Section A: leadership”, the UK
governance code asserts that every company should have a sounding board that contributes
to the long -term success of a company in alignment with their statutory duties,
with a clear definition and differentiation of responsibilities of each board
member. David Alan Tyler, who is the present Chairman, has the innate competencies
to lead the board of Sainsbury, considering that he had broad and extensive experience
in 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, In
the annual report, a clear definition of each of the committee’s and senior
level executive’s responsibilities were explained thoroughly, stating that
David would be responsible for the leadership of the board, Mike Coupe would be
responsible for day-to-day management of the business and Susan Rice would act
as an intermediary between other Directors and Mike. The titles of chairman and
chief executive officer were also separated clearly in the annual report as an
avoidance to high concentration of power in the hands of one executive.

Secondly, in “Section
B: Effectiveness”, the UK governance code illustrates that the board should be
composed of the right set of knowledge and skill sets that would enable
effective discharge of statuary duties and responsibilities. Each board of
directors of Sainsbury had significant and relevant past experience that are
conducive to their current title and responsibilities to contribute to the
long-term success of the firm. For example, Senior Independent Director Susan
Rice had previous experience in retail banking and financial services, having
assumed the role of managing director and chief executive of Lloyds banking
group Scotland and Lloyds TSB Scotland plc respectively. Therefore, her career experience
is particularly relevant to Sainsbury’s ownership of Sainsbury’s Bank. Moreover,
a nomination committee is currently present in Sainsbury’s board structure to
conduct rigorous and transparent procedures for the appointment of new
directors, with most of its members being independent directors, hence
complying with section B of the code.

 

Thirdly, based on “Section C: Accountability”, the UK
corporate Governance Code dictates that the auditing board structure should
consist of at least three independent non-executive directors, along with the
requirement that at least one member of the audit team acquired relevant
financial experience prior to joining, which is imperative in order to persuade
the public and shareholders of the competency and expertise that the audit team
possess relevant to the business sector to which the company operates. In
relation to Sainsbury’s accountability section, the auditing board consists of
David Keens, Matt Brittin and Brian Cassin, who are all identified as independent
non-executive directors. According to Bloomberg, since David Keens possesses profound
financial experiences given his involvement with Next PLC as Group Finance
Director and served as Group Treasurer with NEXT from 1986 to 1991, combined
with his 7 years of management expertise in the accountancy profession, it can be
said that David Keens is a nice addition to the audit committee. Other auditing
board members also had significant experiences retail sector experiences.
Therefore, as a whole, Sainsbury’s auditing board structure shows competency in
its internal audit monitoring process and complies with the requirements of the
UK Corporate Governance Code.

 

 

Fourthly, based on “Section D: Remuneration” of the UK Corporate
Governance Code, Sections D.2 suggests that the remuneration committee under
the board structure should implement a transparent and rigorous procedure for
policy developments concerning remuneration at the executive level. Section D.2.1.
elaborates further by suggesting that there should be a remuneration committee
consisting of at least three independent non-executive directors, in which the
chairman can also be considered a committee member if he or she was appointed
as independent in the first place. According to the remuneration report,
Sainsbury’s remuneration committee during the year 2017 comprised of Mary
Harris (Chairman), John McAdam, Susan Rice and Jean Tomlin, who are all
classified as independent non-executive directors. Moreover, the specific responsibilities
and roles of the committee were all explained in detail, thus persuasive enough
to justify the authority delegated to the committee by the board.  Hence, the remuneration committee’s board
structure of Sainsbury has successfully complied with the recommended one
indicated in the UK Corporate Governance Code.

 

Last but not least,  in”Section E: Relations with stakeholders”, Section E.1
and E.2 of the UK governance code respectively suggests that efficient dialogue
should take place between a company and its shareholders based on mutual
understanding of company objectives and that general meetings are encouraged as
a medium to communicate with them. Section E.1.2, in particular, dictates that “the board should
state in the annual report the steps they have taken to ensure that the members
of the board…develop an understanding of the view of major
shareholders about the company”. In their annual report, Sainsbury has
successfully complied with this supporting principle by listing that the board
had met with large investors and institutional shareholders through a number of
mediums, including presentations, invitation to stores and concessions, conference
calls, road shows, etc. The content of these presentations and conference
meetings were also posted on their website as to reach a wider group of
investors. Moreover, Important shareholder contact responsibilities were also
clearly defined amongst the top executives, as Mike Coupe, Kevin O’ Byrne and
James Collins were the main points of contact for shareholders, with the
Chairman and Susan Rice (Senior Independent Director) attending to investor
meetings regularly. Sainsbury also complied with Section E.2 as it held an
annual general meeting to allow shareholders to meet and question the Board on
5 July 2017. It was stated in their annual report that all resolutions were
passed with majority voting based on a poll vote.

 

The UK Corporate Governance Code is of great importance to shareholders because
it allows them to identify Sainsbury as a trustworthy company that would align performance
with their own interests, which is to gain a return for lending capital to it
in the first place. MacNeil and Xiao (2006) explains that some companies choose
to comply with the code due to the fact that the code represents the public and
institutional investor’s view on the definition of best practice, and therefore
means 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 gain
in the shares they hold. In my view, lack of compliance to the code may cause
shareholders to lose faith in the company and potentially fear that they may
suffer a huge loss. For example, a company that does not clearly outline its
board responsibilities may cause shareholders to suspect that the board members
are not on the same page and do not share a similar vision for the long-term
success of the company. Or for example, if Sainsbury did not follow the rules
of Section C.3.1, which as before, suggested that at least one member of the
audit committee have relevant financial experience, and employed
non-independent directors that had no financial exposure, it might lead
shareholders to be skeptical about the competency of the audit board to monitor
its internal process, thus may give rise to “creative accounting” or “earnings
management”. Thus complying with the code is a means of maintaining public
confidence and retaining shareholder’s interests.