224 Agency Theory The principle agency relationships arise when parties engage

224 agency theory the principle agency relationships

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2.2.4 Agency Theory The principle agency relationships arise when parties engage other persons to perform some service on their behalf, which involves delegating some work in making authority to the agents. The contract between the parties will typically contain a set of commissions in order to limit divergences between their interests. In order to ensure desirable results, the principals will also pay upfront costs. Issues associated with the separation of ownership and controls are intimately associated with agency problems. It follows that capital structure theory and agency problems are related. Jensen and Meckling investigate the incentives faced by the parties involved. A company can be seen as an intermediary for a set of contracting relationships among individuals. The firm is a legal fiction, which serves as a focus for a complex process in which the conflicting objectives of interested parties are brought into equilibrium within a framework of agreed relationship. Agency theory has contributed to the corporate governance literature and the regulation of listed companies. The analysis of potential conflicts of interest supports the formulation of rules concerning shareholder rights, investor protection, disclosure and transparency. Asymmetric information is important for the distribution of power between managers and shareholders, because managers always know more about the company than the external owners do, but asymmetric information plays a broader role in financial markets. 2.4 Empirical Review 2.4.1 Growth of Derivative markets 16
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Adelegan (2009) pointed out that the South African Futures Exchange grew out of an informal market in April 1987.At that time a local merchant bank, Rand Merchant Bank, started an informal financial market. Subsequently, option contracts were introduced in October 1992, agriculture commodity futures in 1995 and a fully automated trading system in May 1996.The Equity Derivative division of the Johannesburg Stock Exchange (JSE) has been in the operation since 1990, coordinating trading activities in warrants, single stock futures (SSF), and equity indices and interest rate futures and options. Market participants are retail investors, professional traders, asset managers and short –term equity traders. According to Batson’s court report (2003), the flexibility of derivatives contracts also affords opportunities for abuse. For example, Enron’s bankruptcy illustrates how Enron was able to borrow significant sums from investors without showing the associated debt in its public accounts, by using families of options or forwards on energy commodities. Each such family derivatives position formed a circle of offsetting contracts whose net cash flows were those of a routine debt contract. Even the rating agencies (Moody’s, standard and poor’s) were unable to see through the lack of disclosure of these debt positions.
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