Agency Issues Relating to Multinational Companies

Introduction

Shareholders consider establishment of a manager-shareholder relationship as the most important aspect in the success of their investment. This is arises from the fact that it is the managers who are charged with the obligation of day to day operation of the firm. Despite this, Clayman, Fridson and Troughton (2008, p.43) are of the opinion that a firm may not attain this due to existence of agency problem. Multinational firms mostly delegate the management of their subsidiaries to other managers. Agency problems arise when agents acts in a manner that can lead to economic loss to their principals. In their operation, multinational companies mainly employ managers from the host country since they are conversant with the foreign countries business environment. As a result, an agency relationship between the parent and the subsidiary is established. Managers are expected to maximize the shareholders wealth. As a result, their decision should be to the interest of the shareholders investment (Madura, 2006, p.2). However, Cheng and Hitt (2004, p.186) are of the opinion that some managers of subsidiary companies may prioritize their personal goals and make decisions that conflict with the shareholders wealth maximization objective. The agency problem may also arise due to existence of information asymmetry and risk preferences. According to Black, Hashimzade and Myles (p.7), existence of information asymmetry limits the effectiveness with which the parent company can monitor the activities of the subsidiaries. For example, the agents may capitalize on the existing information asymmetries between the two parties and pursue their own interest. This means that it becomes too difficult for the principal to know what the agents are doing (Dorrenbacher & Geppert, 2011, p.154). Yukl, Gordon and Taber (2002, p.15) are of the opinion that it is important for shareholders to monitor the behaviors of the managers to ensure that they act in accordance with what is stipulated.

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In an effort to deal with these challenges, multinational companies incur significant agency costs. According to Madura (2008, p.3), agency costs are relatively high in the case of multinational companies compared to domestic companies. Multinational companies in different economic sectors are faced with agency problem. Some of these companies include banks. This paper is aimed at illustrating the various agency issues relating to multinational companies. In addition to other general multinational companies, the paper takes into account firms in the bank industry.

Agency issues experienced by multinational companies and banks

Conflict of goals

The diverse agency issues that multinational companies face arise from a number of factors. One of the agency issue that multinational companies face relate to conflict of goals. The parent company may not be able to control the operations of the subsidiaries. This arises from the fact that the firm may have a large number of subsidiaries which are dispersed in different regions. As a result, it may not be able to deal with the specific problems faced by the subsidiaries (Reddy,2008, p. 195).

In addition, some of the decision made by the subsidiary firms may counter the overall objective of the parent firm. For example, a multinational company may decide to venture into the foreign country by establishing a subsidiary where the cost of operation is low. Upon producing the goods, the subsidiary firm will be expected to sell to its host country market. However, the management team of the subsidiary may decide to export to the domestic market. The resultant effect is that the subsidiary company robs the domestic firm of its business rather than exploiting the foreign market.

In the case of a bank, the parent company may have a stipulated regulation which the subsidiary bank may be expected to follow. However, the subsidiary firm may face a different business environment in the host country. As a result, the subsidiary firm may be constrained in instituting different financial structures and regulations that are inline with changes in the host country business environment ( Caprio, Evanoff and Kaufman, 2006, p.34). This is due to the fact that these measures may conflict with those stipulated by the parent company. For example, for a multinational bank such as the Citibank, it may decide to adopt a global strategy in all its operation. This means that the managers of the subsidiary firms will be required to sell universal products. This may be inefficient in contributing towards the firm meeting the specific needs of the foreign market (Millineux & Murinde, 2003, p.47). Alternatively, the subsidiary bank may decide to develop financial products that meet the market demand. However, some of these products may be risky which means that they may increase the probability of the subsidiary firm collapsing (Herring, 2002, p.64).

In addition to conflict of goals, the managers of multinational companies may make decisions which contribute towards improvement in their compensation ( Jones, 2005, p.34). For example, the managers of subsidiary firms may decide to undertake risky ventures for their own personal benefit (Clayman, Fridson & Troughton, 2008, p.43). This is mainly so if the managers of a subsidiary firm have stock options in the firm and they may decide to undertake high risky investment. The decision may be motivated by the fact that they may receive large returns in the event of the venture paying off. Similarly, the subsidiary company may decide to utilize the funds allocated to the firm for operation in undertaking expansion of the firm (Schoenmaker & Sander, 2004, p.35). The core objective behind such a decision may arise from the need by the managers of the subsidiary firm to ensure that they have a job security, increase their power within the firm and also their remuneration. However, such decisions may be undertaken without taking into account the shareholders interest. For example in the case of a multinational bank, the managers of the subsidiary firm may decide to increase their benefits or prerequisites which are they may be treated as expenses to the company. By enjoying such benefits, it is the shareholders who incur the cost.

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According to Eisenbeis (2004, p.15), it is important for a multinational bank to implement effective designs that have a certain degree of flexibility to deal with challenges as they arise.

To deal with conflict of goals, Madura (2008, p.252) is of the opinion that the management team of parent company should ensure that the managers of the subsidiary firm understand the fact that some of the decisions aimed at maximizing the performance of the subsidiary may have adverse effects on the parent company. One of the ways through which the management team can attain this is by instituting effective governance. In addition, the parent company should ensure that the managers of subsidiaries understand the firm’s overall goal and give them a certain degree of flexibility to deal with market changes.

Despite this, subsidiaries should focus on maximizing the performance of the multinational firm and not that their individual performance (Yukl & Lepsinger, 2005, p.34). To attain this, multinational companies should institute a reward system that recognizes managers of subsidiaries that adhere to the overall multinational corporation goal. For example, the multinational company can give the managers of the subsidiaries an opportunity to purchase shares thus making them to be part owners. This way, there is a high probability that the managers will be concerned with the performance of the multinational.

Management control

A study conducted by Meric and Gulser (2001, p.146), most multinational banks operating in the United States are not as efficient compared to multinational partners owned by Americans. Some of the reasons for the existence of difference are associated with inefficiency in implementing management strategies and the nature of the organizational structure implemented (Meric & Gulser, 2001, p.146). To deal with challenges presented by the business environment of the host country, the parent multinational company may give the management team of the subsidiary company discretion to operate independently. This may be attained by incorporating a decentralized management style. According to Yukl (2008, p. 708), effective leadership through adoption of an effective management style can contribute towards the success of a firm.

Such a management style gives the management team of the subsidiary firm a high degree of control (Bliss, 2003, p.54). However, such a management style may cause the parent company to incur significant agency cost. For example, the decentralized system may compromise the firms overall objective. This is due to the fact that the management team of the subsidiary in the foreign country may make decisions that are aimed at maximizing the performance of the subsidiary. It may be challenging for the parent country to monitor the subsidiary firm.

Difference with domestic firms

Agency issues experienced by multinational companies are relatively more compared to domestic firms. For example, multinational companies such as banks are usually large in size. In addition, the subsidiaries are dispersed in different countries which may make it to be challenging for the parent company to monitor the activities of the managers. According to Madura (2007, p.4), the parent company may incur a high cost in an effort to monitor the subsidiaries in foreign company compared to a firm with subsidiary firms in the domestic country. This means that there is a high probability of subsidiaries in foreign country engaging activities that contravene the shareholders wealth maximization objective.

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Secondly, agency problems for multinational companies may be relatively high due to existence of cultural differences between the domestic and the host country (Kao, Chiou and Chen, 2004, p.43). This is mainly so if the parent company decides to use expatriates from the domestic country in its subsidiary firm. For example, in the case of a multinational bank, the firm’s managers may not be conversant with the existing culture in the host country which means that the managers may not be effective in attracting customers (Mullineux & Murinde,2003, p. 46). Additionally, if the manager of the subsidiary firm is not conversant of the existing culture, he or she may not be concerned with following the laid down goals. Additionally in the case of an American firm which has ventured into the international market through establishment of a subsidiary firm and appoints a non-American to run the firm may face a great challenge. This arises from the fact that the manager of the subsidiary may not take into account the importance of formulating and short term decision in order to deal with short term effects. The resultant effect is that the decisions made by the manager of the subsidiary firm being inconsistent with the shareholders objective of wealth maximization.

In the domestic market, the multinational company may not face cultural differences. This means that manager of the subsidiary may be effective in implementing the various goals. According to Baumuelller (2007, p.182), multinational companies such as banks experience differences in culture which may prove challenging to deal with. For example, some managers of the subsidiary company selected from the host country may not value some aspects due to difference in culture.

Conclusion

For a multinational company to be successful in the foreign market, it is paramount for it to hire managers to coordinate the operation of its subsidiary firms. By delegating the management of the subsidiary, an agency relationship is created. However, there are instances where the managers of the subsidiary firm may not act in the overall interest of the multinational. This means that there may be existence of conflict of goals. For example, of the subsidiary firm may make decisions that are aimed at maximizing the value of the subsidiary firm. However, such an action may have adverse effect on the parent company. In order to deal with such a situation, it is important for the parent company to ensure that managers of the subsidiary firms understand the firms overall goal. This can be attained by integrating an effective communication system between the parent and the subsidiary firm.

Secondly, the managers of the subsidiary firm may pursue their personal interest leading to creation of agency problems. For example, by investing some of the money meant for catering for the operation of the subsidiary, the managers may decide to undertake unnecessary expansion. The resultant effect is that the firm may not be able to attain the intended wealth maximization objective. To deal with this challenge, multinational companies such as banks should ensure that there is effective governance between the parent and the subsidiary firms. One of the ways through which this can be attained is by incorporating an effective reward system. Additionally, the firm should ensure that there is an efficient communication between the parent and the subsidiary firm.

From the above analysis it is evident that multinational companies are faced with different agency issues compared to domestic companies. For example, in an effort to maximize the shareholders wealth, multinationals may establish a large number of subsidiaries which are distributed in different countries. In such a case, it becomes challenging for the parent company to monitor the operations of the subsidiary. This may not happen in a firm that has subsidiaries in its domestic country. Additionally, multinational company may experience a challenge to existence of differences with regard to culture. Despite these challenges, multinational companies tend to experience relatively more agency issues compared to domestic firms.

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