The separation of ownership and management activities, and the presence of discrepancies in information, may cause conflicts of interest. For example, a manager’s personal interest may lead to misuse of financial resources by investing in risky projects at the expense of the stakeholders who paid the capital. Therefore, to control conflicts of interest and reduce agency costs, and various internal and external instruments, the concept of corporate governance has been proposed. For example, a board of directors was established as a solution to these conflicts. The board of directors is considered the most powerful internal control body for senior management because the board of directors has the ability to recruit, dismiss and compensate senior management.
Another solution to conflict of interest management is to link compensation to managers with the company’s performance. However, when an effective board of directors exists to provide the required information, senior management compensation is seldom based on the company’s performance. When there is a strong corporate governance system it will contribute to removing or at least contributing to reducing conflicts of interest between shareholders and management. Therefore, the efficiency of the corporate governance system is likely to be strengthened if the board’s role as a control and oversight tool is emphasized.
Three important issues that invited researchers to write in the corporate governance system, as follows:
First: Conflicts of interest may occur between stakeholders such as managers, shareholders and creditors, because business decisions that increase the welfare of one of these groups – usually often – reduce the welfare of other groups.
Second: Varied information may give managers freedom to act, and this in turn may lead to opportunism in behavior. So that the administration may seek to achieve its own goals by using the funds for their personal benefit, investment and financing ineffectively so that this behavior will reduce the profitability of the company. The existence of such a conflict of interest between shareholders and managers may affect the quality of profits, and therefore this conflict may affect the performance of the company.
Third: Another reason behind the study of corporate governance is the financial scandals of some companies that occurred at the beginning of the twenty-first century, such as: Enron, Arthur Anderson, WorldCom, and Adelphia.
For these three reasons mentioned above, the study of the corporate governance system has become – in abundance – an urgent need for many researchers.
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