The archaic concepts of agency theory: a South African accounting practice perspective

100 Pages·2014·1 MB·English

by  Madelie Olivey

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Surname, Initial(s). (2012) Title of the thesis or dissertation. PhD. (Chemistry)/ M.Sc. (Physics)/
M.A. (Philosophy)/M.Com. (Finance) etc. [Unpublished]: University of Johannesburg. Retrieved
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THE ARCHAIC CONCEPTS OF AGENCY THEORY: A SOUTH AFRICAN ACCOUNTING
PRACTICE PERSPECTIVE
by
MARGARETHA MAGDALENA OLIVEY
MINOR DISSERTATION
Submitted in the partial fulfilment of the requirements for the degree
MAGISTER COMMERCII
in
INTERNATIONAL ACCOUNTING
in the
FACULTY OF ECONOMIC AND FINANCIAL SCIENCES
at the
UNIVERSITY OF JOHANNESBURG
SUPERVISOR: DENNIS DEYSEL
MAY, 2014

Supervisor: D Deysel
Acknowledgements

I would like to thank my family and friends, but most importantly, my amazing husband for
the support and love during the time of writing this minor dissertation. Thank you to my
supervisor, Mr Dennis Deysel for all your help and support in shaping this minor dissertation.
You guys rock!
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Table of Contents
Acknowledgements .............................................................................................................................. 2
Table of Contents ................................................................................................................................. 3
Chapter 1: Introduction ........................................................................................................................ 5
1.1 Change is inevitable in development ................................................................................ 5
1.2 The origins of the Agency Theory and its impact on financial reporting .................... 10
1.3 Problem statement ............................................................................................................. 13
1.4 Research objective ............................................................................................................. 13
1.5 Research methodology ..................................................................................................... 13
1.6 Delineation and limitations ................................................................................................ 16
1.7 Rationale for the study ....................................................................................................... 17
1.8 Brief chapters overview ..................................................................................................... 17
Chapter 2: Agency Theory ................................................................................................................ 18
2.1 Introduction .......................................................................................................................... 18
2.2 Positive Accounting Theory .............................................................................................. 19
2.3 The Agency Theory ............................................................................................................ 20
2.4 Positivist Agency Theory ................................................................................................... 29
2.6 Conclusion ........................................................................................................................... 34
Chapter 3: Literature on proponent views on the Agency Theory .............................................. 35
3.1 Introduction .......................................................................................................................... 35
3.2 Changes in the business environment, ownership and incentive strategies ............ 35
3.3 Identification of general principles ................................................................................... 50
3.4 Conclusion ........................................................................................................................... 51
Chapter 4: The development of the Companies Act ..................................................................... 52
4.1 Introduction .......................................................................................................................... 52
4.2 Changes included under the new Act ............................................................................. 53
4.3 An analysis of the most significant changes to the new Act and the Agency Theory ..
…………………………………………………………………………………………………………………………………………56
4.4 Identification of general principles ................................................................................... 59
4.5 Conclusion ........................................................................................................................... 61
Chapter 5: The development within the accounting practice ....................................................... 62
5.1 Introduction .......................................................................................................................... 62
5.2 What has changed in how an entity is viewed? ............................................................. 64
5.3 What is the importance of the shareholder? .................................................................. 69
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5.4 What is the influence of stewardship? ............................................................................ 71
5.5 What is the role of the shareholder? ............................................................................... 73
5.6 Identification of general principles ................................................................................... 76
5.7 Conclusion ........................................................................................................................... 77
Chapter 6: Conclusion ....................................................................................................................... 79
6.1 Introduction .......................................................................................................................... 79
6.2 Principles identified from the Agency Theory ................................................................ 80
6.3 Compare and contrast of the principles of the Agency Theory and recent literature
on business practices ........................................................................................................ 81
6.4 Compare and contrast of the principles of the Agency Theory and the new Act ..... 84
6.5 Compare and contrast of the principles of the Agency Theory and accounting
practices ................................................................................................................................. 85
6.6 Conclusion ........................................................................................................................... 89
6.7 Scope for future research.................................................................................................. 90
Bibliography ........................................................................................................................................ 92

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Chapter 1: Introduction

1.1 Change is inevitable in development

Without me trying to rewrite history or steal the thunder from many historians, it was William
Pollard who said: “without change there is no innovation, creativity, or incentive for
improvement. Those who initiate change will have a better opportunity to manage the
change that is inevitable” (Brainyquote, 2014). In the words of the famous George Bernard
Shaw, “progress is impossible without change, and those who cannot change their minds
cannot change anything” (Brainyquote, 2014). These truths equally apply to accounting
practice. Over the past few years, many factors have contributed to changes in accounting
practice.

1.1.1 Change in communication and its impact on financial reporting

One of the greatest inventions of our time is the internet (Burkeman, 2009). “It's impossible
to say for certain when the internet began, mainly because nobody can agree on what,
precisely, the internet is” (Burkeman, 2009). People do, however, seem to agree that it was
around 1969. Much has changed since the internet began in 1969. Consider even the
briefest summary of how much has happened on the global stage since 1969: the Vietnam
War ended; the Cold War escalated then declined; the Berlin Wall fell; communism
collapsed; Islamic fundamentalism surged (Burkeman, 2009). Google, Facebook, Twitter,
smartphones, tablets and e-readers — technologies that originated in the consumer space
— are now reshaping the way companies communicate and collaborate with employees,
partners and customers (Burkeman, 2009).

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1.1.2 Change in environmental and social responsibility and its impact on
financial reporting

Al Gore, a recent Nobel laureate, in his documentary film on global warming titled An
inconvenient truth, hammered home the dangers of overconsumption. Since this
documentary, scientists have found that carbon dioxide had little to do with the recent
warming. In fact, all heavy particulate pollution generated in earlier decades cooled the
atmosphere by dimming the sun. Due to a combined effort and social pressures to reduce
carbon omissions, scientists have found that we are actually reversing the damage caused
in earlier decades, which in essence fuels the debate on global warming (Levitt and Dubner,
2010).

In addition to what has happened in science, the Enron scandal, which was exposed in
October 2001, eventually led to the bankruptcy of the Enron Corporation, an American
energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen,
which was one of the five largest audit and accountancy partnerships in the world, changed
the financial reporting landscape forever. In addition to being the largest organisation to go
into bankruptcy in American history at that time, the Enron debacle has been described as
one of the biggest audit failures (Bratton, 2002). It also heralded a dramatic change in how
financial statements are reported on, and emphasised the need for transparency in both
auditing and financial reporting.

The International Integrated Reporting Council (“IIRC”) recently published the “Consultation
Draft of the International Integrated Reporting Framework, 2013”. In its introduction, the IIRC
states that “corporate reporting needs to evolve to provide a concise communication about
how an organisation’s strategy, governance, performance and prospects, in the context of its
external environment, lead (sic) to the creation of value over the short, medium and long
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term”. Its focus is on the strategy of the company as defined and implemented by
management to ensure its continuation well into the future. The report identifies the key
audience for this report as “providers of financial capital”. It further states that “although
providers of financial capital are the primary intended report users, an integrated report and
other communications resulting from Integrated Reporting will be of benefit to all
stakeholders interested in an organisation’s ability to create value over time, including
employees, customers, suppliers, business partners, local communities, legislators,
regulators and policy-makers” (IIRC, 2013).
The term “shareholders” has not been used, but has instead been replaced by the term
“providers of financial capital” with reference to other stakeholders. Management is reporting
on value creation to providers of financial capital as investors, rather than owners. “The
organisation’s strategy identifies how it intends to maximise opportunities and mitigate of
manage risks” (IIRC, 2013).

1.1.3 Change in capital markets and its impact on financial reporting

We also experienced the global financial crisis that started in 2008, and that ultimately
questions the core of any economic or accounting theory grounded in the notion that
economists assume that in all instances markets are efficient and individual action is driven
by self-interest (Phillips, 2011). In his article, Phillips (2011) questions the economist’s theory
of a perfect economy and asks why, if markets are efficient, we experienced a global
economic crisis. He gives “incentives” as the answer. In other words, the incentive was too
great in the short term for JP Morgan bankers to sell Collaterised-Debt Obligations (“CDOs”),
riddled with poor quality mortgage bonds, to investors as Triple A-rated mortgage bonds in
the booming house market in the USA. These bankers were paid to sell as many of these
CDOs as possible, regardless of their performance, which then, given enough time for the
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poor-quality mortgage bonds to default in multitudes, led to the beginning of the global
economic crisis (Phillips, 2011).

Some research also suggests that global investment markets have drastically altered the
nature of ownership. Roberts refers to investors as “modern day gamblers of the private
equity and hedge fund strategies” and believes that they should not be regarded as owners
at all (Roberts, 2006: The Agency Theory). Roberts (2006) also makes an interesting point in
saying that “the terms of business has changed”. “Ownership has been replaced by
investment, and a company’s assets are increasingly found in its people, not its buildings
and machinery” (Robert, 2006: The Agency Theory). He further states that those charged
with governance are actually predisposed to respond to outside political pressures and
governance rules in order to appear to act in a certain way. Even though the landscape has
changed, with agents acting in the traditional role of the principal, and in turn the principal
reduced to the role of an investor, entities remain dependent on the financial capital provided
by investors and need therefore to continue to attract new investors and maintain
stakeholders’ interests.

1.1.4 Change in regulatory pronouncements and its impact on financial
reporting

The world has changed in recent years in political, social, and economic terms, and
governance, reporting to investors and regulatory pronouncements have also changed.

The International Accounting Standards Board (“IASB”) has recently undertaken a project to
rewrite the conceptual framework, and as part of this project it undertook to define what an
entity is and how it should be described. In terms of the Exposure Draft issued by the IASB
Conceptual Framework for Financial Reporting – The Reporting Entity (“ED/2010”), an entity
is described as an “area of economic activities” and is characterised by three features: (a)
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“economic activities of an entity are being conducted, have been conducted or will be
conducted”; (b) “those economic activities can be objectively distinguished from those of
other entities and from the economic environment in which the entity exists”; and (c)
“financial information about the economic activities of that entity has the potential to be
useful in making decisions about providing resources to the entity and in assessing whether
the management and the governing board have made efficient and effective use of the
resources provided”. These features are necessary but not always sufficient to identify a
reporting entity (ED/2010: 9).

The proposed definition includes some of the characteristics of a “business” as an integrated
set of activities, but is not limited only to inputs, processes and outputs as per International
Financial Reporting Standards (“IFRS”) 3 Business Combinations (IFRS, 2013). The IASB
has received comment letters in response to the question in the exposure draft on whether
correspondents agree with the definition and characteristics proposed. This will be a key part
in the study in understanding how an entity and its shareholders are viewed under a practical
application of theories of accounting.

It is refreshing to see that the proposed definition does not make reference to return
generated for the owner, but that “management” and “resources to the entity” have been
incorporated; these are terms used within the Entity Theory (refer to Chapter 5 for a detailed
discussion). This change in use of terminology suggests that accounting practice has
evolved to reflect current business practice. Unfortunately, accounting is taught within a
framework of assumptions, and one of these assumptions pertains to the relationship that
exists between the shareholder and the company.

In addition to changes in financial reporting standards, changes in certain regulatory
pronouncements relating to the concept of an “entity” are found in the Companies Act 71 of
2008. The Act was recently rewritten, and this, according to KPMG, fundamentally changed
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