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In general, corporate governance is about problems that arise between a principal and an agent. Imagine you have just set up company and you – as a principal – have hired a CEO – as an agent – to run your business. The CEO may take actions that are beneficial for him, but not for you. The costs associated with such actions are called agency costs.

For example the CEO might pay himself an excessive salary and buy an oversized company car. So how do you make sure he runs your company in your interest? One option is through monitoring which means that you actively supervise what the CEO is doing. In companies, monitoring is a prime task of the supervisory board.

Another option is through incentives. Instead of paying him a flat salary, you might pay him a performance related salary or even give him a stake of your company, thereby aligning the CEO’s interest with your interest. This way the company’s value has a direct impact on
the CEO.

With organisational structures like those you can ensure that you get a return of the money you invested.