OWNERSHIP STRUCTURE AND AGENCY PROBLEMS

Financial theory before 1976, illustrated that companies like "black boxes" in processing inputs into outputs. The company is assumed to provide a rational response to economic incentives and ignore managers' existence as managing the company. Since 1976, Jensen and Meckling have incorporated the human element in an integrated model of corporate behavior and described the company as a collection of contracts between parties interacting within the company. When the owner manages a company, all actions taken by the entrepreneur are their consequences. However, if the owner sells part of his ownership, he no longer bears the consequences of his actions but has already been shared with other parties who bought part of his ownership. The relationship that occurs between the manager and the owner of the company is a contractual relationship.

A contractual relationship, both explicit and implicit, will involve one or more people referred to as the principal who asks others to take action on behalf of the principal called an agent. This contractual relationship is called an agency relationship. The agent is given authority for decision making by the principal. In the company's context, the principal is the owner of the company and the agent is the management team. Based on the agency perspective, there is a separation between ownership and control of the company. The investor is giving the management authority to make decisions related to the company's strategy and operations. The investor hopes that the decisions taken will maximize the value of the company. However, management has personal interests in general, is mostly in conflict with the interests of the owner of the company so that the agency problem arises.

Agency problems in companies can come in many forms, depending on the ownership structure of the company. The ownership structure spreads to many investors with a relatively small proportion of ownership to each investor. It will cause agency problems between managers and shareholders because investors whose proportion of ownership is relatively small are reluctant to control the behavior of managers directly. Meanwhile, the manager's ownership in the company is also relatively small, so the desire to maximize the value of the company is also low. The agency problem between the principal and management is called the type I agency problem.

Managers tend to expropriate in type I agency problems. Expropriation is the process of using controls to maximize one's own welfare at the expense of others. Expropriation can occur due to asymmetric information both related to activities and information held by the agent. As a result of expropriation by management, shareholders can classify themselves substantially as controlling or majority shareholders to gather information and supervise management. Under these conditions, the agency conflict that occurs is not between management and shareholders but between majority shareholders and minority shareholders. This conflict is a type II agency conflict.

Type II agency's problem arises in the ownership of concentrated shares. The main essence of a type II agency problem is the separation of control rights and cash-flow rights. La Porta, Silanes, and Shleifer prove that controlling shareholders’ cash flow rights are substantially different from their control rights. The higher the deviation of control rights and cash flow rights between controlling and non-controlling shareholders, the higher the problem of type II agency problems. The shareholders tend to expropriate in the form of asset redistribution—the controlling shareholder distributed to controlling shareholders and not obtained by minority or non controlling shareholders. When viewed from a concentrated ownership structure, the controlling shareholder is the ultimate shareholder, and management is the arm of the controlling shareholder.

La Porta, Silanes, and Shleifer found five types of ultimate ownership: family or individual, the State, and widely owned financial institutions such as banks or insurance companies, widely owned companies, and others such as cooperatives. The ultimate owner can increase his control rights with the pyramid mechanism and cross-ownership. The controlling right of the controlling shareholder implies that the entrenchment effect it has. Fan and Wong stated that entrenchment is an act of controlling shareholders protected by his control right to pass abuse of power in the form of expropriation of non-controlling shareholders. If the controlling shareholder has substantial cash flow rights, it will be able to prevent the expropriation of non-controlling shareholders. The actions of the controlling shareholders in harmony with the interests of the minority shareholders imply an alignment effect.