Social Security and Pension Reform: International Perspectives

13- Pension Fund Governance, Adam Samborski

287 13 Pension Fund Governance Adam Samborski Poznań School of Banking This chapter analyzes the formal institutions of corporate governance for pension plans. It applies this analysis to open pension funds, which are mandatory individual account plans, operating in Poland. Each pension fund has a specific institutional arrangement, which determines to a large extent its effectiveness. Such an arrangement sets the pension fund under the influence of many stakeholders. The primary objective of regulations in the governance area of pension funds becomes a minimization of potential agency problems—conflicts of interest that may arise between the pension participants and those responsible for the fund’s management. PRINCIPAL–AGENT PROBLEM In agency theory, agency relationships are understood as contracts under which a principal engages a third party (agent) to perform certain actions on their behalf in dealing with a second party, which is the provider of the service. The essence of agency theory can be reduced to two basic assumptions. First, expectations and objectives of principal and agent are various and remain in conflict (difference of interests, different objective function). Second, it is very difficult and expensive for the principal to check the agent’s work. In agency theory the basic concept is the agency relationships (Szczepański 2010). In pension arrangements, the plan participant is the principal, the plan sponsor is the agent, and the financial institution managing the pension funds is the second party. This implies the need for the principal to delegate certain powers to the agent to make certain decisions. In order to view this proof accurately, the Overprint Preview Option must be checked in Acrobat Professional or Adobe Reader. Please contact your Customer Service Representative if you have questions about finding the option. Job Name: -- /356308t 288 Samborski Then an agency relationship arises, which can be a public contract (formal, explicit) or an implicit contract (informal). The purpose of the contract is to ensure such actions of the agent so that he/she strives to maximize the principal’s benefits. However, between the agent and the principal there is an asymmetry of information. This can lead to the agency problem, which usually occurs in two situations: hidden action of the agent, and hidden information or hidden knowledge possessed by the agent (Mesjasz 2002). In the first situation, the agent takes action, the course or outcome of which cannot be observed by the principal, resulting in the risk of moral hazard (the inclination of someone who is imperfectly checked to take part in behavior which may be dishonest or undesirable). In the second situation, the agent has information about environment variables, which the principal does not have before or after the conclusion of the contract. Ex ante asymmetry can lead to adverse selection, with the party having the superior information benefiting at the expense of the party with inferior information (Mesjasz 2002). Agency problems can be prevented by concluding a complete contract , which will take into account all possible aspects and options of future situations. However, drawing up a complete contract is not feasible . Thus, we are dealing with incomplete contracts between principals and agents (Mesjasz 2002). Agency problems can be limited in three ways: 1) reduction of information asymmetry, 2) seek harmonization between the principal’s and the agent’s objectives , and 3) building trust. There are two options for reducing information asymmetry: screening (the principal keeps track of the agent in the corporation) and signaling (the agent gives specific signals to the principal, such as reports). Second, the interests of the principal and the agent can be harmonized by introducing incentive schemes (such as managerial options ). Third, the agency problem can be reduced by agents building reputational capital that they want to maintain (Brink 2007). Shaping the behavior of the agent in such a direction that his or her actions diverge from the principal interest as little as possible requires incurring certain costs, including drawing up contracts, monitoring and controlling the conduct of the agent by the principal, ensuring the interests of the principal, and residual loss (Aluchna 2002). In order to view this proof accurately, the Overprint Preview Option must be checked in Acrobat Professional or Adobe Reader. Please contact your Customer Service Representative if you have questions about finding the option. Job Name: -- /356308t Pension Fund Governance 289 AGENCY PROBLEMS IN PRIVATE PENSION FUNDS AND WAYS TO LIMIT IT Three levels of retirement provision can be distinguished under pension plans. The...