EFFECTS OF AGENCY PROBLEMS ON FIRMS’ VALUE

A SURVEY OF SELECTED LISTED COMPANIES IN NAKURU, KENYA

i
 KEY WORDS
Agency theory: Agency theory is concerned with resolving problems that can exist in
agency relationships; that is, between principals (such as shareholders)
and agents of the principals
Principal: The owner of a private company
Board monitoring: Exercise of oversight over managers and senior employees of a
company by the board of directors.
Bonding costs: A guarantee of performance required, either by law or consumer
demand, for many businesses, most typically general contractors,
temporary personnel agencies, janitorial companies and businesses with
government contracts
Residual loss: This occurs whenever the actions that would promote the self-interest
of the principal differ from those that would promote the self-interest of
the agent.
Corporate governance: The system of rules, practices and processes by which a company is
directed and controlled.

ii
 ABSTRACT
There exists the universal problem in corporates of difficulty in assuring that the firm, as agent,

does not behave opportunistically toward these various other principals. This paper aimed at

investigating the effects of agency problems on Kenyan firms‟ value in. The specific objective of

the paper were; To investigate the specific agency problems in Kenyan corporates; To quantify

agency costs incurred by the shareholders; To assess the effect of agency problem on net worth

of business and to come up with effective solutions to the agency problem. A quantitative

research design was used to achieve these objectives. The researcher carried out a survey study

on 15 companies in Nakuru town and the findings were presented in tables. Two sets of linear

regression models were computed to represent the findings. According to the study findings

improper use of firm assets, administrative expenses, Board costs and HR bonding costs had

negative impact on firms‟ value.

iii
 TABLE OF CONTENTS
KEY WORDS ................................................................................................................................. ii
ABSTRACT ................................................................................................................................... iii
TABLE OF CONTENTS ............................................................................................................... iv
LIST OF TABLES .......................................................................................................................... v
1.0 INTRODUCTION .................................................................................................................... 1
2.0 RESEARCH PROBLEM .......................................................................................................... 3
3.0 OBJECTIVES ........................................................................................................................... 4
3.1 General Objectives ................................................................................................................ 4
3.2 Specific objectives................................................................................................................. 4
3.3 Hypothesis ............................................................................................................................. 5
4.0 REVIEW OF LITERATURE ................................................................................................... 6
4.1 Theoretical Framework ......................................................................................................... 6
4.2 Agency and Resource Dependence Theories ........................................................................ 9
4.3 Board Performance and the Agency Theory ....................................................................... 10
5.0 Conceptual Framework ........................................................................................................... 13
6.0 RESEARCH METHODOLOGY............................................................................................ 14
7.0 RESEARCH FINDINGS ........................................................................................................ 16
8.0 CONCLUSIONS AND RECOMMENDATIONS ................................................................. 23
REFERENCES ............................................................................................................................. 25

iv
 LIST OF TABLES
Table 1: Agency problem and assets value ................................................................................... 16
Table 2: Coefficients of relation between agency problems and asset values .............................. 17
Table 3: Correlation: asset value and agency problems ............................................................... 18
Table 4: Agency costs and company performance ....................................................................... 19
Table 5: Regression Coefficients: agency costs and gross profits ................................................ 20
Table 6: Correlations: gross profits and agency costs .................................................................. 21

v
 1.0 INTRODUCTION
The main purpose of business administration and financial management is to pursue perpetual

growth of a corporation such that the wealth of its stockholders could be maximized. Ever since

the disastrous financial tsunami in 2008, corporate financial distresses occurred to several well-

known giant enterprises, including the National Bank of Kenya, Citibank and American

International Group (AIG). Governments have since initiated financial bailout projects in order

to save these corporations from financial distress. Surprisingly, several companies, after

receiving government bailout funding, they propose enormous bonus compensation plans to the

management as well as the board of directors. For instance, AIG decided to issue a bonus

compensation plan amounted to $165 million dollars to senior management even though the plan

had been severely criticized by the press. This notorious case presented a dilemma to

government policy-makers whether the government should assist these troubled companies out

of corporate financial distress.

Academicians, however, examine the issue in order to find an answer for the dilemma from

several different perspectives. For example, firms are suggested to improve their corporate

governance and business ethics in order to reduce the self-interest motives of management and to

avoid management‟s moral hazard, while agency theory examines how management‟s behavior

could be directed at stockholder‟s interest by reducing agency cost. According to Brush,

Bromiley, and Hendrickx (2000), agency theory holds based on three premises: First, the goal of

management is to maximize his/her personal wealth instead of stockholder‟s wealth. Second,

management‟s self-interest motivates waste and inefficiency in the presence of free cash flows

1
(FCF). Third, agency costs are incurred to the burden of stockholders because of weak corporate

governance.

The main problem comes up when the principal cannot monitor the agent‟s performance. The

shareholders of a corporation who hires the manager to work for them have a big challenge in

getting the manager to act in their interests because of the likelihood of the manager acting in his

own interest. This is caused in part by the principal‟s inability to observe the agents actions and

the existence of information asymmetries. Information asymmetries occurs when there is

difference in the information processed by the two parties i.e. the principal and the agent. The

agency theory assumes that every person will give up as little as possible in any exchange.

Agents according to Boatright (2008), can then be expected to engage in opportunism by seizing

any chance to enrich themselves at the expense of the principal. The principal / agency

relationship suggests that hired managers will have different objectives from that of the owners

as they will use the firm‟s resource to satisfy their own demand (Oyejide and Soyibo, 2001).

It is difficult to avoid conflicts in corporates because in acting as an intermediary for other

peoples‟ transaction and custodian of their financial assets, the agents are often forced to choose

among the competing interest of others and weigh them against their own. This conflict primarily

arises as a result of trying to provide as many possible services as they can to different parties at

the same time. In corporates, the agency problem is mainly between the management and the

shareholders and solutions are likely to be found in the procedural rules and incentive contracts

or it could come in the form of external support through regulations. According to Arun and

Turner (2003), however, the nature of the contractual form of corporates in developing

economies calls for corporate governance mechanisms in the banks to include both the

depositors and the shareholders.

2
In Kenya, poor corporate governance has been identified to be responsible for the distress in

several public owned corporates over years. So far many corporates have either closed or have

been struggling to survive for a number of years. A perfect example in Kenya is the Pan paper

industry, the Publicly owned sugar industries and the National bank. With the recapitalisation

these corporates have still survived amid challenges except pan paper industry. Key amongst

these challenges were the availability of the required skills and competencies needed by the

board of directors and management to improve the shareholders value and balance of same

against other stakeholders interests in a competitive environment (Central Bank of Kenya, 2006).

This paper attempted to investigate the agency problem in kenyan corporates and how it affects

firms value, the breakdown in the corporate governance code, the various ways the regulatory

authorities have come out to curb the problem and also the measures that are being put in place

to forestall a reoccurrence.

2.0 RESEARCH PROBLEM

In particular, almost any contractual relationship, in which one party (the „agent‟) promises

performance to another (the „principal‟), is potentially subject to an agency problem. The core of

the difficulty is that, because the agent commonly has better information than does the principal

about the relevant facts, the principal cannot easily assure himself that the agent‟s performance is

precisely what was promised. As a consequence, the agent has an incentive to act

opportunistically, skimping on the quality of his performance, or even diverting to himself some

of what was promised to the principal. This means, in turn, that the value of the agent‟s

performance to the principal will be reduced, either directly or because, to assure the quality of

the agent‟s performance, the principal must engage in costly monitoring of the agent. The greater

3
the complexity of the tasks undertaken by the agent, and the greater the discretion the agent must

be given, the larger these „agency costs‟ are likely to be.

Three generic agency problems arise in business firms. The first involves the conflict between

the firm‟s owners and its hired managers. Here the owners are the principals and the managers

are the agents. The problem lies in assuring that the managers are responsive to the owners‟

interests rather than pursuing their own personal interests. The second agency problem involves

the conflict between, on one hand, owners who possess the majority or controlling interest in the

firm and, on the other hand, the minority or noncontrolling owners. Here the noncontrolling

owners can be thought of as the principals and the controlling owners as the agents, and the

difficulty lies in assuring that the former are not expropriated by the latter. The third agency

problem involves the conflict between the firm itself including, particularly, its owners and the

other parties with whom the firm contracts, such as creditors, employees, and customers. Here

the difficulty lies in assuring that the firm, as agent, does not behave opportunistically toward

these various other principals such as by expropriating creditors, exploiting workers, or

misleading consumers.

3.0 OBJECTIVES

3.1 General Objectives

The general objective of this paper was to investigate the effects of agency problem on firm‟s

value in Kenyan Corporates.

3.2 Specific objectives

i. To investigate the specific agency problems in Kenyan corporates

ii. To quantify agency costs incurred by the shareholders

iii. To assess the effect of agency problem on net worth of business

4
 iv. To assess the effects of agency costs on company performance

3.3 Hypothesis
The hypothesis for this study was based on the general objective of the study. The hypothesis

stated as follows;

H10: The agency problem has no significant effect on firm‟s value

H11: The agency problem affects the firm‟s value

H21: Agency costs have no significant effect on firms‟ performance

H22: Agency costs have significant effect on firms‟ performance

5
 4.0 REVIEW OF LITERATURE

4.1 Theoretical Framework

Agency Theory

The 1976 article, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership

Structure by Jensen and Meckling helped establish AT as the dominant theoretical framework of

the CG literature, and position shareholders as the main stakeholder (Lan et al. 2010, Daily et al.

2003). The adoption of the agency logic increased during the 1980„s as companies started

replacing the hitherto corporate logic of managerial capitalism with the perception of managers

as agents of the shareholders (Zajac et al. 2004). The subsequent stream of iterature would break

with the tradition of largely treating the firm as a black box and the assumption that the firm

always sought to maximize value (Jensen 1994). AT addressed what had become a growing

concern, that management engaged in empire building and possessed a general disregard for

shareholder interest, what Michael Jensen called “the systematic fleecing of shareholders and

bondholders” (1989), through providing prescriptions as to how the principal should control the

agent to curb managerial opportunism and self-interest (Perrow 1986,Daily et al. 2003). As the

market reacted positively to this change in logic, with time the agency approach became

institutionalized in the practice of CG, within business education, research and media (Zajac et

al. 2004; Shapiro 2005, Lan et al. 2010).

Agency theory is concerned with resolving problems that can exist in agency relationships; that

is, between principals (such as shareholders) and agents of the principals (for example, company

executives). The two problems that agency theory addresses are: 1.) the problems that arise when

the desires or goals of the principal and agent are in conflict, and the principal is unable to verify

(because it difficult and/or expensive to do so) what the agent is actually doing; and 2.) The

6
problems that arise when the principal and agent have different attitudes towards risk. Because of

different risk tolerances, the principal and agent may each be inclined to take different actions.

The Creation of Agency Costs

The problem of moral hazard leads to costs for the firm associated with administering the

contract, hereunder contracting, transaction, moral hazard and information costs–namely agency

costs (Gomez-Mejia et al. 2005, Jensen et al. 1985). The level of the costs will depend on the

ability of the principal to find an appropriate solution to reducing information asymmetries

through measuring managerial performance, determining effective incentives, as well as

implementing rules and regulations to limit unwanted behavior or moral hazard (Brickley et al.

1994, Gomez Meija et al. 2005). Whilst achieving zero agency costs is practically impossible, as

the marginal costs of doing so will eventually be higher than the accompanying benefits of

perfect alignment (Jensen et al. 1976), monitoring and incentives intends to minimize them

(Eisenhardt 1989, Jensen et al. 1985, Shapiro 2005).

Agency Costs

The agency problem was originally raised by Berle and Means (1932) who argued that agency

costs might be incurred in the separation of ownership and control due to inconsistent interests of

management and stockholders. Jensen and Meckling (1976) suggested that the incomplete

contractual relationship between the principal (stock-holders) and the agent (management) might

cause the agency problem. In general, the agency problem caused by management would cause a

loss in stockholders‟ wealth in the following ways: First, management, from the aspect of self-

interest motive, would increase perquisite consumption and shirking behavior, which in turns led

to an increase in agency costs. Second, management might not choose the highest NPV

investment project, but the one that maximized his own self-interest, which would expose

7
stockholders to unnecessary investment risk. Therefore, management‟s decision might cause the

firm‟s loss in value because the best project was not chosen.

It was obvious that the agency problem caused by management would burden the stockholder‟s

loss, yet it was not clear how the agency costs were defined as well as measured. Early literature,

such as Jensen and Meckling, argued that there were at least three forms of agency costs:

monitoring cost of management‟s actions, bonding cost of restrictive covenants, and residual loss

due to suboptimal management‟s decisions. Jensen (1989) linked the agency problem with free

cash flows such that management might abuse free cash flows at their authority when investment

opportunities were not readily available to the firm. There-fore, free cash flows to management

were agency costs to stockholders.

To tackle the agency problem, two contrasted approaches, the refraining approach and the

encouraging approach were suggested. Kester and Gul and Tsui (1998) took the refraining

approach and argued that an in-crease in financial leverage would sufficiently reduce the agency

costs since management is subjective to legal bonding of repaying debt and interest, which in

effect might decrease the abuse of free cash flows. In addition, Shleifer and Vishny (1999) and

Bethel and Liebeskind (1999) proposed that corporate takeover could discourage man-agement‟s

incentive to perquisite consumption and shirking behavior. Furthermore, Crutchley and Hansen

(1989) implied that the firm could attempt to distribute idle cash flows to stockholders by stock

repurchase or dividend payments to avoid the abuse of free cash flows.

By contrast, Lehn and Poulsen (1995), Fox and Marcus (1992), and Dial and Murphy (1996)

suggested the encouraging approach that a firm could change management‟s action to be more in

favor of stockholders by increasing the shares held by management.

8
Although abundant literature has reviewed the agency theory, yet the measurement of agency

costs was still not clearly defined, thus depending on proxy variables. According to literature,

there were seven proxy variables suggested to measure agency costs: They are total asset

turnover; operating expense to sales ratio, administrative expense to sales ratio, earnings

volatility, advertising and R & D expense to sales ratio, floatation cost (Crutchley and Hansen,

1989), and free cash flows (Chung et al., 2005). Therefore, the paper also intends to empirically

test which proxy variable would better serve as the measurement of agency costs.

4.2 Agency and Resource Dependence Theories

Hillman & Dalziel (2003) define the agency theory assumes that owners of an organization

(principals) and those that manage the organization (agents) have different interests. Hence

owners will face the problem that managers are likely to act according to their own interests

rather than the owners‟ interests (Fama & Jensen 1983). In this regard, boards are required to

monitor managers on behalf of the owners. In performing this role, members are expected to be

independent and monitor the actions of managers as agents of the owners to ensure they are

acting in accordance with the owners‟ interests (Jensen & Meckling1976). The theory suggests

that board composition is important for effectively monitoring top management (Hussein &

Kiwia 2009). Boards have to be diverse in terms of skills, experience, and gender balance. This

creates a balance on boards and leads to effective monitoring and subsequently to the successful

performance of the organization.

In addition to monitoring, board members are also required to provide organizations with

resources (Hillman & Dalziel 2003). The provision of resources is linked to the resource

dependence theory.

9
This theory holds that organizations are interdependent (Pfeffer & Salancik 1978) in that they

depend on each other and various actors for their survival as well as for resources. As a result,

they need to find different ways of managing this dependence and ensuring they get the

resources and information they need. From this perspective, the board is seen as one means of

reducing uncertainty by creating influential links (Hillman & Dalziel 2003; Peng 2004). Board

members provide organizations with various resources through board members‟ skills,

experience, and expertise. Pfeffer and Salancik (1978) also note that „when an organization

appoints an individual to a board, it expects the individual will come to support the organization,

will concern himself with its problems, will invariably present it to others, and will try to aid it‟.

Diversity in the composition of boards is important if boards are to effectively provide advice

and resources. Board members with different skills and experience and of both genders

contribute to effective resource provision and to the beneficial performance of organizations. In

summary, both theories advocate that boards should have a diversity of competent members who

are able to effectively monitor top managers and provide organizations with the resources they

need. By performing these roles, board members are able to positively influence the performance

of organizations.

4.3 Board Performance and the Agency Theory

Several studies in other have examined the effect of board composition on the performance of

organizations. These studies make an important contribution as they show how board composite

on can benefit or harm performance. Hermalin and Weisbach (1991) studied the effect of board

composition on the financial performance of listed companies in the United States. They defined

board composition in terms of the percentage of board members who are employees of

organizations (internal board members) and of board members who are outsiders. Their sample

consisted of 142 companies listed on the New York stock exchange and used pooled data of five
10
years. Their results indicated that there was no strong relationship between board composition

and firms‟ financial performance. The major explanation for this was that board composition

simply does not matter. Inside and outside directors are equally bad (or possibly good) at

representing shareholders‟ interests.

Another related study was conducted by Sanda, et al. (2005), who examined corporate

governance mechanisms and the financial performance of organizations in Nigeria. The authors

looked at board size (defined as number of board members), board composition (defined as

proportion of external board members), and top management experience (defined in terms of

whether the CEO comes from another country). Their sample consisted of all companies listed

on the Nigerian stock exchange. Their results regarding board composition were found to

partially and positively influence organizations‟ financial performance. They also reported that

small size was effective up to certain numbers, after which it becomes ineffective. This implies

that large boards (with more than ten members) are not very efficient. They further found that

organizations with international CEOs who are part of the board outperformed those which did

not have international CEOs. This finding is similar to Oxelheim and Randøy (2003), who

studied the influence that foreign board members have on organizations‟ values. These authors

studied organizations in the Scandinavian countries and analysed the relationship between

foreigners on boards and organizations‟ values. They found that organizations which had at least

one foreign board member outperformed those which did not have a foreigner on their boards.

The authors concluded that foreign board members are able to bring a variety of experiences and

expertise, which can benefit the organizations.

Hussein and Kiwia (2009) studied the relationship between female board members and the

performance of 250 US firms from 2000 to 2006. Their findings indicate a positive relationship

11
between firm performance and the level of female representation inside the boardroom. They

further show that organizations that perform well tend to appoint more females to their boards so

as to concede to government pressure, especially in developed countries.

Barako et al. (2006) studied the relationship between corporate governance attributes and

voluntary disclosure in Kenyan listed companies. The authors examined the extent to which

board composition (defined as the percentage of external board members) and the existence of

board audit committees affect company disclosure (defined as the release of financial and non-

financial information through annual reports above mandatory requirements). Their results in

regard to board composition reveal a negative relationship between the existence of external

board members and voluntary disclosure, which implies that external board members do not

matter much when it comes to convincing companies to reveal information.

Hartarska (2005) examined the link between the governance mechanisms and performance of

MFIs in Central and Eastern European countries. She studied how managerial compensation,

board size and independence (percentage of external board members), prudent regulations, and

auditing affect financial and outreach performance. The results with regard to boards show that

boards with greater external representation have better financial performance and boards with

employee representation (internal) result in poorer financial and social performance. Similar

findings regarding board composition were revealed by Hartarska and Mersland (2012) and Mori

and Mersland (in press), who used a large sample to study which governance measures promote

efficiency in reaching poor clients. These studies defined performance as efficiency in reaching

to many poor customers. Using the agency and stakeholder theories as a basis for their

arguments, they looked at measures such as board size, board composition (percentage of

internal board members), and managerial capture. Their results regarding boards show that MFIs

12
with a larger proportion of insiders (employees) on the board are less efficient. They concluded

that MFI boards with many internal members do not impact social and financial performance.

5.0 CONCEPTUAL FRAMEWORK

Independent variables Intervening variables Dependent variables

Agency problems

Residual Losses from Firms Value

management decisions
Asset value
Management
Firms performance
administrative
expenses

Improper use of firm

Assets

Board Monitoring

Corporate governance

Bonding Costs

13
 6.0 RESEARCH METHODOLOGY
Research Design

The study used a quantitative survey research design. quantitative survey was chosen for the

study because it allows the researcher to study phenomena by manipulating variables and

observing to derive relationships (Kombo & Tromp, 2006). A survey was conducted to collect

data from all the selected companies in Nakuru town. It sought to study the effects of agency

problems in kenyan firms‟ value.

Target Population

The study was carried out in Nakuru town. Nakuru town is one of the fast growing towns eyed

by many investors in Kenya. Most companies operating countrywide have opened a branch in

Nakuru due to its attractiveness to investors. The target population was all managers and

accountants from the 15 companies selected for the study.

Sampling technique and sample size

The study applied convenience sampling technique to select 15 companies for the study. This

was based on accessibility of the company by the researcher and availability of their

management. She then purposively selected managers and accountants from each company. The

sample size was therefore 30, comprising of 15 accountants and 15 managers.

Data collection methods

The study utilised primary data obtained by the researcher from sampled companies. Data was

collected using the questionnaire designed by the researcher based on the study objectives.

Questionnaires are more systematic and structured and aimed at obtaining information from

respondents in a direct and open manner. Shao (1999) points out that a questionnaire may be

14
structured, consisting of direct questions to obtain factual data, or indirect semi structured,

allowing more flexibility on the part of the interviewer in setting questions in an indirect manner,

or probing for answers. Questionnaires were then administered through drop and pick later

method due to the likely busy schedules of the targeted reespondents.

Data Analysis

Data collected was first be cleaned and entered in to MS Excel for ease of analysis. In the

analysis, Quantitative data was analyzed using regression analysis to obtain relationships.

Statistical inferences were then drawn on the relationships between agency problems under study

and firm‟s value using Pearson‟s correlation analysis. These were performed with the aid of

Statistical Package for Social Sciences (SPSS).

The model

The research findings will be presented in a linear regression model. The model will take the
following form;

Yn will stand for the dependent variables namely Asset value and gross profits. b‟s are the model

coefficients and x‟s stand for independent variables.

15
 7.0 RESEARCH FINDINGS
This section presents the study findings and discussions on effects of agency problem on firm

performance. The researcher collected data across the 15 companies sampled and findings

presented in tables.

Agency problem and Asset value

The researcher sought to determine the relationship between the various agency problems and

company asset value. The findings are presented in table 1 below.

Table 1: Agency problem and assets value

company Residual Asset Usage admin expenses Growth in
Losses (%) outside company (salaries and Assets (%)
(hours outside commissions %)
company per
day)
Innovative Computer 9.8 0.5 30 18
Solutions Ltd
Homes & Shelter Africa Ltd 1.9 1.1 9 16
JOSWIN ACADEMY 12.6 2 35 9
Survey and Statistics 3.3 0.2 42 15
Solutions Kenya
Patmat Bookshop Ltd 1.2 0.6 53 24
Premier Seed 6.1 0.8 48 11
Bliss Tours & Travels 10.8 0.2 32 26
Agencies
Ashleys events 11.2 2.1 21 22
Equity Bank Limited 3.6 0.15 9 19
ABC Bank - African 4.2 0.9 12 16
Banking Corporation
Chip Intel (k) Ltd 6.6 0.6 28 31
Molten Rock Safaris 7 0.12 33 32
EVOLUTION 5 2.2 52 8
COMPUTERS
Hyrax General Supplies 8.8 0.09 54 8
Crater Automobile 8.4 1.5 23 14

16
In the above table the study used growth in assets as the determinant of asset value. All

companies sampled recorded a significant growth in asset value with percentage between 8% and

26%. The researcher developed a linear regression model to compute the relationship between

the different variables. A correlation analysis and goodness of fit analysis was also run to

determine the magnitude and direction of relationship between each variable with the dependent

variable and determine the extent to which variable under study influence asset value.

The model

Using OLS method the researcher developed the following coefficients;

Table 2: Coefficients of relation between agency problems and asset values

Standardized
Unstandardized Coefficients Coefficients

Model B Std. Error Beta

1 (Constant) 25.270 6.127

Residual Losses (%) .196 .601 .089

Asset Usage outside -4.587 2.814 -.443

company (hours outside
company per day)

admin expenses (salaries -.145 .131 -.290

and commisions %)

17
Table 3: Correlation: asset value and agency problems

Asset Usage
outside
company admin
(hours outside expenses
Growth in Residual company per (salaries and
Assets (%) Losses (%) day) commisions %)

Pearson Correlation Growth in Assets (%) 1.000 -.045 -.404 -.264

Residual Losses (%) -.045 1.000 .275 .042

Asset Usage outside -.404 .275 1.000 -.050

company (hours outside
company per day)
admin expenses (salaries -.264 .042 -.050 1.000
and commisions %)

The three independent variables exhibit a weak correlation with our dependent variable. Asset

usage outside the company exhibit the highest correlation of -0.404 followed by administration

expenses (-0.264) and residual losses from management decisions exhibiting the weakest

negative correlation of -0.045. R squared of the model was 0.252 implying that the variables

under study account for only 25.2% of change in asset value.

Agency costs and Company Performance

The study also carried out a deep analysis on the other indicator used for company performance.

The researcher sought to determine the relationship between gross profits and the agency costs

involved in controlling the agency problems studied above. Table 5 below shows the results from

15 companies sampled.

18
Table 4: Agency costs and company performance

Company Board HR bonding Expenses from Gross

costs (% costs (% corporate governance profits (%)
profits) profits) bureaucracies (%
profits)

Innovative Computer 0.8 0.06 0.03 38

Solutions Ltd
Homes & Shelter 2.3 1.2 1.3 18
Africa Ltd
JOSWIN ACADEMY 5 1.8 1.2 28

Survey and Statistics 1.2 0.08 0.1 42

Solutions Kenya
Patmat Bookshop Ltd 0.6 0.2 1.1 13

Premier Seed 1.3 1.2 1.6 24

Bliss Tours & Travels 1.8 1.1 0.07 30

Agencies
Ashleys events 1.2 2.1 2.9 45

Equity Bank Limited 2.2 3.2 1.8 24

ABC Bank - African 2.4 3.8 1.9 26

Banking Corporation
Chip Intel (k) Ltd 0.3 1 0.9 36

Molten Rock Safaris 2 1.2 0.8 32

EVOLUTION 0.4 0.04 0.02 29

COMPUTERS
Hyrax General 0.08 0.09 0.03 27
Supplies

Crater Automobile 1 1.9 3.2 35

Gross profits are yearly percentage of the total investment, and the costs are in form of

percentages of gross profits. All companies sampled showed positive profits. The researcher used

19
went further to develop the statistical relationship between these costs and company

performance. The results are shown in the regression model below.

The model

The following are the coefficients of the model calculated using the OLS method;

Table 5: Regression Coefficients: agency costs and gross profits

Standardized
Unstandardized Coefficients Coefficients

Model B Std. Error Beta T Sig.

1 (Constant) 30.876 4.554 6.780 .000

Board costs (% profits) -1.102 2.524 -.157 -.437 .671

HR bonding costs (% -.577 3.669 -.077 -.157 .878

profits)

Expenses from corporate 1.163 3.585 .139 .324 .752

governance bureaucracies
(% profits)

The model showed that expenses on corporate governance improved profits by 13.9% while

board costs and HR bonding costs reduced profits by 15.7% and 7.7% respectively. R squared of

the relationship was 0.223 implying that the variables under study account for only 22.3&

change in profit.

A correlation analysis between the independent variables and gross profits is as shown below;

20
Table 6: Correlations: gross profits and agency costs

Expenses from
corporate
governance
Gross profits Board costs (% HR bonding bureaucracies
(%) profits) costs (% profits) (% profits)

Pearson Correlation Gross profits (%) 1.000 -.169 -.063 .053

Board costs (% profits) -.169 1.000 .523 .203

HR bonding costs (% -.063 .523 1.000 .698

profits)

Expenses from corporate .053 .203 .698 1.000

governance bureaucracies
(% profits)

All the variables exhibited weak correlation coefficients. Expenses on corporate governance

exhibited a weak positive correlation with profits while board costs and HR bonding costs

exhibited weak negative correlation of -0.169 and -0.063 respectively.

Hypothesis Testing

The study had two sets of hypothesis each with null hypothesis and alternative hypothesis.

The first set of hypothesis was;

H10: The agency problem has no significant effect on firm‟s value

H11: The agency problem affects the firm‟s value

This was tested by studying the relationship between agency problems and asset growth. R

squared of the relationship was 23% therefore the agency problems under study had significant

effect on firms‟ value. The study therefore accepts the alternative hypothesis H11.

The second set of hypothesis was;

21
H21: Agency costs have no significant effect on firms‟ performance

H22: Agency costs have significant effect on firms‟ performance

This was also tested by studying the R squared of the relationship between agency costs under

study and gross profit. The R squared was 25% exhibiting a significant influence. The study

therefore accepts the alternative hypothesis H22.

22
 8.0 CONCLUSIONS AND RECOMMENDATIONS
In this section, the study presents conclusions and recommendations drawn from the findings.

Conclusions

The study general objective was to study the effects of the agency problem on firms‟ value. The

researcher broke down this objective in to asset value and firm performance as indicators of firm

value. She computed two sets of relationships on factors affecting asset value and those affecting

company profitability. The model developed by the researcher on the relationship is

, where Y0 stands for asset growth rate, x1, x2 & x3 stand for

residual losses from management decisions, Asset Usage outside company and administrative

expenses respectively. In this study Y0 stand for a proportion of 22.3% of the total asset growth.

From the above model residual losses from management decisions create another effect on the

other side to cancel out the loss and instead account for 8.9% of Y0. Asset usage outside the

company creates the largest effect on asset value. From the research findings and the model

above it implies that asset usage outside the company reduce Y0 by 44.3%. In other words asset

usage outside the company negatively impacts the proportion of asset growth under study by

44.3%. Administration expenses also reduce asset value as per the study findings. These

expenses account for a reduction of 29% of Y0. They therefore reduce asset value.

The other set of relationship developed by the study was that between performance (gross profit)

and agency costs. The regression model derived was ,

where Y1 stands for 25% of gross profit, y1, y2 and y3 stand for Board costs, HR bonding costs and

expenses on corporate governance. From the study findings expenses on corporate governance

have the impact of improving Y1 by 13.9% while board costs and HR bonding costs reduce Y1 by

15.7% and 7.7% respectively.

23
Recommendations

This study therefore recommends the following; asset usage outside the company should be

minimised to reduce asset maintenance cost and depreciation. If assets have to be used outside

the company they have to be those whose depreciation rate can be minimised and care must be

exercised with the people using them bearing all costs associated with their usage when doing

duties outside scope of the company; administrative costs should also be minimised as they have

not shown total efficiency in eliminating asset wastage. Instead of spending on supervisors on

every process, internal control systems should be involved in such processes so as to reduce

administrative costs and achieve efficiency in control of asset use; Board costs and Human

Resource bonding costs should be minimised to the lowest. Work of the board should be well

structured to reduce number of incidences where board members have to receive allowances for

little tasks. Costs incurred by the board should also be controlled to avoid costs that are too high.

On the other hand corporate governance should be encouraged. Expenditure on corporate

governance has shown to be worthwhile and therefore companies should be committed to having

every structure that make the system of governance work.

This paper recommends further study on other factors that influence firms value and a study to

investigate why residual losses from management decisions have a positive correlation with firm

value.

24
 REFERENCES

Cantwell, J. (2003). International business and the eclectic paradigm developing the OLI

framework. London: Routledge.

Chung, D. (2005). Investor's business daily and the making of millionaires: how IBD rewrote the

rules of investing and business news. New York: McGraw-Hill.

Garvey, M., & Garvey, A. J. (1992). Philosophy and opinions of Marcus Garvey. New York:

Atheneum ;.

Hermalin, B. E., & Weisbach, M. S. (1991). The effects of board composition and direct

incentives on firm performance. Rochester, N.Y.: William E. Simon Graduate School of

Business Administration, University of Rochester.

Hillman, B., & Dalziel, R. E. (1992). Ethics and agency theory: an introduction. New York:

Oxford University Press.

Jensen, R. (1994). Marketing modernism in fin-de-siècle Europe. Princeton, N.J.: Princeton

University Press.

Khodr, H. M. (2008). Scheduling problems and solutions. New York: Nova Science Publishers.

Liu, L. (2010). Conversations on leadership: wisdom from global management gurus. New

York: New York State School of Industrial and Labor Relations, Cornell University.

Mejia, L. R., Balkin, D. B., & Cardy, R. L. (2005). Management: people, performance, change

(2nd ed.). Boston: McGraw-Hill/Irwin.

Pfeffer, J., & Salancik, G. R. (1978). The external control of organizations: a resource

dependence perspective. New York: Harper & Row.

Sanda, A., & Mikailu, A. S. (2005). Corporate governance mechanisms and firm financial

performance in Nigeria. Nairobi: African Economic Research Consortium.

25
Shapiro, S. (2005). Environment and our global community. New York: International Debate

Education Association.

26