Content area
Full text
1 Introduction
Separation between ownership and control of corporations characterises the existence of a firm. The design of mechanisms for effective corporate control to make managers act in the best interest of shareholders has been a major concern in the area of corporate governance and finance ([2] Allen and Gale, 2001), and continuing research in agency theory attempts to design an appropriate framework for such control. In a corporation, the shareholders are the principals and the managers are the agents working on behalf of, and for the interests of, the principals. In agency theory, a well-developed market for corporate controls is assumed to be non-existant, thus leading to market failures, non-existence of markets, moral hazards, asymmetric information, incomplete contracts and adverse selection among others. Various governance mechanisms have been advocated which include monitoring by financial institutions, prudent market competition, executive compensation, debt, developing an effective board of directors, markets for corporate control, and concentrated holdings. Developing an effective board of directors remains an important and feasible option for an optimal corporate governance mechanism.
The limitations of the current literature in this field are the following. Currently, several formal models exist based on the effectiveness of the board of directors in designing efficient control mechanisms for corporate governance. However, for a multi-level decision system such as corporate governance, an improved model including uncertainty in model parameters is necessary to resolve the uncertain nature of the agency problem in corporate governance. In addition, the modelling studies of monitoring CEOs by the board, using empirical data, to resolve the agency problem in a more quantitative form are not well-known in the current literature.
The objectives of this paper are; to provide an improved model for corporate governance based on an effective board of directors and to analyse the results of this model for the effectiveness of boards and their monitoring of the CEO. This study is also expected to enrich the current literature by providing an empirical assessment of CEO performance and monitoring, in precise quantitative terms.
The paper is structured in the following way: Section 2 presents the principal theoretical concepts covered by the selected literature on the agency theory in finance, and on the role and composition of boards. Section 3 presents a model to...