Shareholders and by extension, the company they own operate within the environment using the charter or licence granted by the government. The government will expect the company and by extension its shareholders to operate the business in a manner which is beneficial to the entire economy and the society.
The government in this agency relationship is the principal while the company is the agent. It becomes an agent when it has to collect tax on behalf of the government especially withholding tax and PAYE.
The company also carries on business on behalf of the government because the government does not have adequate capital resources. It provides a conducive investment environment for the company and share in the profits of the company in form of taxes.
The company and its shareholders as agents may take some actions that might prejudice the position or interest of the government as the principal. These actions include:
- Tax evasion: This involves the failure to give the accurate picture of the earnings or profits of the firm to minimize tax liability.
- Involvement in illegal business activities by the firm.
- Lukewarm response to social responsibility calls by the government.
- Lack of adequate interest in the safety of the employees and the products and services of the company including lack of environmental awareness concerns by the firm.
- Avoiding certain types and areas of investment coveted by the government.
Solutions to the agency problem
The government can take the following actions to protect itself and its interests.
1. Incur monitoring costs
E.g. the government incurs costs associated with:
- Statutory audit
- Investigations of companies under Company Act
- Back duty investigation costs to recover tax evaded in the
- VAT refund audits
2. Lobbying for directorship (representation)
The government can lobby for directorship in companies which are deemed to be of strategic nature and importance to the entire economy or society e.g directorship in KPLC, Kenya Airways, KCB etc.
3. Offering investment incentives
To encourage investment in given areas and locations, the government offers investment incentives in form of capital allowances as laid down in the Second schedule of Cap 470.
The government has provided legal framework to govern the operations of the company and provide protection to certain people in the society e.g. regulation associated with disclosure of information, minimum wages and salaries, environment protection etc.
5. The government can incalculate the sense and spirit of social responsibility on the activities of the firm, which will eventually benefit the firm in future.