ACC620 Contemporary Issues in Accounting
Semester 2 2017
Student Name: Manpreet Kaur (1100637)
Relationship between Board Effectiveness and Climate change disclosure
Task 2 (Agency Theory)
Submission Date: 8 September 2017
(Friday Week 6, 5pm)
I certify that I have carefully reviewed the university’s academic misconduct policy. I understand that the ideas from other sources (books, articles, journals) must be referenced. The quotation marks and a reference list are required when directly quoting anyone else’s words.
An agency relationship is defined as a relationship in which the principals involve the agent to perform services on their behalf that includes allotting some decision-making authority to the agents (Hill and Jones, 1992) and (Jensen and Smith,1985). Jensen and Smith (1985) argue the conflict of interests between principal and agent as the agency problem. Agency theory is concerned with the problem between principal and agent about the separation of ownership and control of firm and functions, risk bearing, and decision making by Morris, (1987). The principals can limit the divergence from their interests by establishing some inducements for the agents. Prado-Lorenzo and Garcia-Sanchez (2010) assigned the Board of Directors to have effective role to control company’s sustainable performance and in being responsible to numerous interest shareholders. An increasing set of initiatives of scientific suggestion concerning to global warming has affected policy makers to take definite steps to manage greenhouse gas emissions (Tauringana and Chithambo, 2014). The objective of this report is to find out the relationship between Board of Director’s effectiveness and voluntary disclosure of climate change.
Ben-Amar and Mcllkenny argued that we are at slanting point regarding climate change. Companies are the main cause of greenhouse gas emission. Environmental problems have become major headings due to the adverse effects of firms. Thus, the increased awareness about environmental concern is now a challenge as climate change increase physical, reputational and litigation risks that may influence the firm’s competitive gain and then economic growth and shareholder’s interest (Uwuigbe and Ajibolade, 2013; Ben-Amar and Mcllkenny, 2015). Stakeholders are more concern about greenhouse gas emission effects and risks associated with climate change. Most of the existing studies explained that companies focusing their attention on identifying various factors that influence them to disclose environmental information as company size, corporate reputation enhancement, fluidity, profitability, and firm performance (Uwuigbe and Ajibolade, 2013 and Fama and Jensen, 1983).
The effects of targets and incentives of the company has been measured with financial performance whereas non-financial performance is typically complicated (Jenson and Smith, 1985). Also, Michelon and Parbonetti (2012) did not find any relationship between board independence and voluntary disclosure by non-financial information. Inclining voluntary disclosure can decline the information asymmetry and then results in the lower cost of external finance (Ben-Amar and Mcllkenny, 2014). The managers prefer to financial related projects as these connected to their compensation and security. They invest in projects having long term benefits. In these cases, agent may conflict with their interest because of information asymmetry problem. This situation needs mechanisms to evaluate managers interest and make them equal with other investors about environmental issues (Tauringana and Chithambo, 2014).
The separation of decision and risk-bearing functions observed in large corporations is common to other organizations such as large professional partnerships, financial mutual, and non-profits. Fama and Jensen, (1983) oppose that separation of decision and risk-bearing functions survives in these firms because of an effective approach to monitoring the agency problems. Agency costs also include the cost of output lost as the expenses of full enforcement of contracts beat the welfares. Hill and Jones argue that principals limit agent’s opportunistic activities by incur some monitoring costs. They also pay some bond costs to the managers to ensure that they will not step any actions those can harm to the principal. There is some divergence remains between the principal’s interest and agent’s act known as residual loss that declines the welfare of principal. The total of the monitoring costs of principals, bond expenses of managers and other residual loss is known as agency costs (Hill and Jones, 1992; Fama and Jensen, 1983).
The lack of comparability of climate change disclosure of firms creates difficulties for stakeholders to evaluate effects of greenhouse gas emissions on their value. Carbon Disclosure Project employs a standard questionnaire to request the information directly from organisations to overcome lack of comparability (Ben-Amar and Mcllkenny, 2015). Agents enjoy total choice over the decisions about disclosure. Also, Ben-Amar and Mcllkenny argue that greenhouse gas emissions are major threats those cause overwhelming effects on environment. Managers face a compromise between the benefits and expenses of participation in and the reporting of emission levels to the CDP annual surveys. Also, the disclosure of greenhouse gas emissions imposes expenditures on the firm that results in inclined scrutiny from regulatory authorities and distract the company’s competitive level (Ben-Amar and Mcllkenny, 2015).
Previous recent studies (Tauringana and Chithambo, 2014; Ben-Amar and Mcllkenny, 2014) suggest that the board of directors is a crucial part to control the sustainable behaviour of any company. According to agency theory, the board serves a monitoring role over management on the behalf of principals as the separation of ownership and management (Fama and Jensen, 1983). The level of independence of Board of Directors’ has a favourable impact on accountability procedures to the all groups of interest. It is presumed that the strength of the Board of Directors is closely related to the degree of independence and diversity of its members. Independence is usually linked to two factors as the presence of independent board members and duality. Independent directors have incentives to establish and retain reputation of being professional experts who efficiently monitor managers and look after the shareholders best interests (Fama and Jensen, 1983). Based on agency theory past studies test that whether independence of directors enhance disclosure transparency. Tauringana and Chithambo states that company’s reputation is stronger if the Board of Directors has many non-executive members because they are more interested in representing compliance with principles and responsible behaviour. Also, non-executive board members are more sensitive to social demands and prefer to ?nd themselves in a better position than executive board members to keep the interests of the stakeholders and do not feel the pressure of competitors which shows positive relationship between board independence and disclosure transparency (Tauringana and Chithambo, 2014). Also, Uwuigbe and Ajibolade, (2013) shows significant relationship between board independence and disclosure at p