Corporate governance and the role of executive incentives Essay

Corporate governance and the role of executive incentives - Essay Example The paper seeks to determine the role and effectiveness of executive incentives in corporate governance drive of an organization and draws the conclusions from various research findings to anchor the understanding of the concept. Inclusion of real life cases assists the application of theories in practical sense. Separating management and ownership is one problem that has always posed serious challenges for corporate form of an organization. The fundamental problem of conflict of interests where managers focusing on personal gains overlooking shareholder’s interest gets severe in loosely governed organization. Corporate governance is a tool which aims to align the interest of all parties and stakeholders in the organization and provides a strategic direction to the performance and control functions by ensuring order and decision making process are done effectively. In this regard, areas where most of the conflicts arise within an organization are related to recruitment and compensation of CEOs and top level management. Based on the above conflicts a detailed theory has been developed which is known as Agency-theory (Jensen and Meckling 1976). The theory describes various types of costs which are incurred owing to the different type of conflicts between shareholders, managers and debt owners. Agency cost is defined as the sum of monitoring cost, bonding costs and residual loss. Other two types of costs are agency cost of equity and agency costs of debt where former arise due to conflict of interests between managers and shareholders whereas latter arises due to conflict between shareholders and debt holders. Corporate governance is a system that brings more transparency and control in the organization. The approach involves setting accountabilities and linking management’s compensation with shareholder’s value. There are many mechanisms that can be applied to