Corporate Governance and Agency Conflicts

ABSTRACT I investigate whether corporate governance is associated with the level of agency conflicts in firms. I employ exploratory principal components analysis on 22 individual governance variables to obtain seven factors that represent the different dimensions of governance for a firm. I measure the level of agency conflicts in firms based on seven proxies for agency conflicts used in the literature. I find that firms with greater agency conflicts have better governance mechanisms in place, particularly those related to the board, audit committee, and auditor. I also find that the composition and functioning of the board, the independence of the auditor, and the equity‐based compensation of directors are significantly associated with firm performance, but primarily for firms with high agency conflicts. Overall, the results support the theory that the existence and role of various governance mechanisms in a firm are a function of the level of agency conflicts in the firm.