The term corporate governance gained popularity following economic and political changes were started in the Organization for Economic Cooperation and Development in the mid-1980s. The above changes contributed to a sudden increase in the activities of the stock market around the world. During this period, the reputation of some organizations around the world was tarnished by numerous scandals and corporate failure in others. Cases of mismanagement in multinational corporations have heightened media attention on the issue of corporate governance. Academicians have also strongly come out to stress the importance of corporate governance. As the need for information disclosure continues, issues of governing the business have continued to crop up. There were widespread corporate excesses which were brought to the public arena by the popular and academic media continued to emerge for the tightening up of business governance. Some of the excesses that were brought up by the popular media and academicians include; excessive salaries and a golden handshake for top management, the appointment of directors and performance linked rewards which focus on short-term decision as opposed to long-term strategic planning. This paper discusses corporate governance and how different theories have tried to explain the concept. The paper will examine some of the common theories of corporate governance and their applicability to corporate governance.
Recent media reports have weakened the confidence that the public has on corporations and increasing calls for changes in the [policy agenda and a strong consideration of the current models to restore the confidence by addressing problems identified in the management and its governance. Many proposals have been given on how to alleviate public and political concerns on the failure of companies. Such proposals once implemented could enhance the accountability of the businesses to its shareholders driven by the desire to enhance confidence in the share market. Corporate governance has become the focus f control and responsibility. It is the mechanism under which the control system of a manager is monitored and determined to enhance the profits of an organization and its shareholder's value (Marie L’Huillier, 2014).
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According to the agency theory, corporate governance is a systemic provision of control over the actions of agents like the management and other workers. The agency theorists were instrumental in developing the policy framework that established the public sector reforms particularly privatization programs. It is important to note that all academic writers do not follow the agency theory view of corporate governance. Some of the academicians write about the topic from different theoretical viewpoints which are not related to agency theory, therefore, offering different perspectives on the topic. Such different perspectives influence the meaning of corporate governance (Marie L’Huillier, 2014).
By examining the theoretical construct surrounding corporate governance, researchers can examine its meaning, relationship, and validity. A theory is an acquired taste contingent of social as well as a political arrangement that elaborates a scholarly practice. There is no overarching theory on the subject under discussion. the concept is still contested having different meanings according to the audience depending on their areas of interest. Some academicians agree that theory on corporate governance is prescriptive and more descriptive research is required. Governance theory is not well routed therefore it will be advisable to understand what is going on firsts instead of forcing a theory into the available space. Some researchers tried to fill the gap by developing tools like the instructive table that has the different dimensions of competing theories that try to explain the concept. The subjective nature of selecting appropriate tools exposes some of the theories to criticism (Marie L’Huillier, 2014).
Academicians have tried to conduct a literature review to understand corporate governance but there is no universally accepted definition or theory that exhaustively examines the concept. Despite growing in its familiarity, corporate governance appears to have multiple definitions and explanations and still, it can be used in different ways. Majority of the literature tries to give a common understanding rather than offering a definition of the concept or even some means that can be used to communicate to the reader so that they can understand what meaning the author is trying to bring forward. It is thus necessary to point out at this point that all academicians do not share a common definition. It is expected that differences over definitions as well as the connotative meaning are expected in new areas of study in social sciences yet corporate governance falls in this category (Marie L’Huillier, 2014).
The variations in the meaning of corporate governance depend on the perspective of the author as perceived from the lens from which the author is borrowing from. The differences can also arise from conflicts in philosophical roots that are either unstated including the theory that emerges from the roots. It can also be argued that the variations in use could arise from intentional acts of discourse that are used to shape the reality. The following theories are to explain corporate governance (Marie L’Huillier, 2014).
Agency theory
This theory can be traced to economics and finance. The principle-agent theory is premised on contractual relationships between an agent and a principal. The agent, in this case, is engaged to perform different services for the principle which involves transferring decision making authority to the agent. The contract so established involves a voluntary exchange that results in dependency. Agency theory can be used to analyze the efficiency of the arrangement due to the contractual relationship. Agency theorist, in this case, portrays people as opportunistic and is driven to maximize their utility and focus on the reward even at the expense of others. The separation of ownership and control creates conflicts of interests between the principle and the owner. Both parties try to achieve maximum benefit using the least expenditures whereas the principal incurs agency costs if the interest of the agent and principal vary. Goal divergence can result in differing mutual benefits which are not optimal and unlikely to achieve fruition. In most cases, the principal loses on optimality because the theory attributes opportunistic tendencies to the agent. Corporate governance issues arise due to the misalignment of the interests between the management and shareholders which is caused by the separation of control and ownership (Marie L’Huillier, 2014).
Agency theorists have focused more on the opportunistic agent at the expense of opportunistic principles. Majority of the literature has concentrated on the potential of an agent to exploit. However, cases are rife where the principal misrepresents themselves thus exploiting agents as agency theory disregards power and authority in the relationship of people. The agency problems that align with separation of control and ownership include; conflicts of interest between both parties, asymmetry in information between the management and owners. Difficulties of writing complete contracts for any eventualities in future (Marie L’Huillier, 2014).
Agency theory tries to conceptualize and rationalize the behavior of humans and the structures in an organization. There are however no distinctions between the public or private sector. In an accounting set up, agency theory is used to understand as well as predict behavior as it assumes competing rationale, focuses on the contractual solutions and conflicts and self-interested players. Agency theory offers a framework for behavior of the different actors, therefore, offering a store of the applicable implications for designing governance structures. According to the agency theory, corporate governance is concerned with creating and monitoring established mechanisms by the shareholders to control the insiders of a corporation thus maximizing wealth by reducing agency cost. Therefore corporate governance role is to ensure that the actions of a corporation, its assets and agents are directed to achieve the overall objectives established by the shareholders (Marie L’Huillier, 2014).
Stewardship theory
It traces its origin to the human relations school of thoughts, organizational theory, sociology, and psychology. It focuses on noneconomic factors that affect managerial activity. A range of nonfinancial motives is considered in this case. Some of the considerations include achievement and recognition, strong work ethics, and the satisfaction from the successful performance. The management strives to achieve high levels of profits for the corporation and realize shareholders return. The financial performance of an organization and the shareholder's wealth are maximized when the management is empowered to exercise unencumbered authority as well as responsibility. Managers, in this case, are team players and are not motivated by personal goals but align their efforts towards the achievement of the principal. A culture of trust must exist between the principal and the agent who in this case is the agent (Marie L’Huillier, 2014).
Directors according to this theory have a fiduciary that they can be trusted and will act as stewards of the company's resources. Managers, in this case, try to maximize the performance of the organization therefore, there are no motivational issues or conflict of interest between the ownership and the management. Corporate power is reallocated from the principal to a professional management team empowered by the corporation to maximize its profits. In the public sector, the model allows the alignment of the management with the ethos of the social enterprise (Marie L’Huillier, 2014).
The basic idea of the concept under stewardship model is that the management is a good steward of the corporate assets and perform their duty to maximize the returns for the shareholders. The performance of the managers is not influenced by personal interest but by the structural situation where is position will affect their performance. Thus structure and hierarchy determine the performance of the management team. Thus according to this theory, corporate governance is achieved through empowering structures that enhance effectiveness and result in a superior outcome. Thus structures that empower and facilitate are better than those that monitor and control (Marie L’Huillier, 2014).
Managerial hegemony
According to this theory, governing boards are the tools used by professional managers to support them in decision making. Professional managers run an organization and it is the managers who make the strategic decision. The board merely rubber stamps the decisions made by the management and only perform as legitimizing figures. According to this theory, shareholders elect the board and give an outward impression that they are in charge of the company. The managers preselect the board members (Marie L’Huillier, 2014).
The board of directors is not engaged in the strategic process of the organization and simply play a cameo role. According to t managerial hegemony, corporate governance involves different phrases like failing to get involved, managers will resist and fictional role of directorates. The professional manager appoints and also reappoints the board. Similarly, directors appointed to the board are likely to possess characteristics of being malleable and understand the politics of the company. The benefits that accrue from being directors offer a disincentive for the board to offset the status quo (Marie L’Huillier, 2014).
Resource dependency theory
It traces its origin to sociology. it focuses on the linking role of the board to other organizations. Corporations depend on each other to access resources thus try to establish links as they attempt to regulate the interdependence. The concept believes in networking directorship and who has the authority to influence the decisions and policies of the large companies. Boards in a business are used to access or absorb interdependencies with external organizations. The interlocking directorship exchange some control and privacy of information in exchange for a commitment for continued support from the other organization. Therefore, according to this theory, the size of the board depends on the need for an organization to respond to the external environment (Marie L’Huillier, 2014).
Stakeholder Theory
It traces its origin to law, politics and management theory. It tends to coordinate the work of the governing board as an organization pursues the interest of its stakeholders. Stakeholders are interested parties who have a legitimate claim to the company. According to this theory, an organization is a constellation of competitive and cooperative interests that possess intrinsic values. The management and the board act in a way that the interest of the stakeholders has intrinsic values. It involves adopting pluralistic approaches to managing organizations. There must be an exchange relationship in this case and the board must understand that there are different groups in the society apart from the shareholders and employees. The board must perform a balancing act with the conflicting interest of its stakeholders. The objective is to establish a primary vehicle that helps in the coordination of the interest of the stakeholders. Structures are established in this case where the different interest groups can state their cases thus reduce information asymmetry (Marie L’Huillier, 2014).
Reference
Marie L’Huillier, B. (2014). What does “corporate governance” actually mean?. Corporate Governance: The International Journal Of Business In Society , 14 (3), 300-319. http://dx.doi.org/10.1108/cg-10-2012-0073
