Rishabh Dutta
M-178
Corporate Governance
Corporate governance is the combination of rules, processes or laws by which
businesses are operated, regulated or controlled. The term encompasses the internal
and external factors that affect the interests of a company’s stakeholders, including
shareholders, customers, suppliers, government regulators and management. The
board of directors is responsible for creating the framework for corporate
governance that best aligns business conduct with objectives.There are many
theories of corporate governance which addressed the challenges of governance of
firms and companies from time to time.
Theories of corporate governance -
● Agency theory -
Agency theory is a principle that is used to explain and resolve issues in the
relationship between business principles and their agents. Most commonly,
that relationship is the one between shareholders, as principals, and company
executives, as agents. Agency theory defines the relationship between the
principals (such as shareholders of company) and agents (such as directors
of company). According to this theory, the principals of the company hire
the agents to perform work. The principals delegate the work of running the
business to the directors or managers, who are agents of shareholders. The
shareholders expect the agents to act and make decisions in the best interest
of principal. On the contrary, it is not necessary that agents make decisions
in the best interests of the principals. The agent may succumb to
self-interest, opportunistic behavior and fall short of expectations of the
principal. The key feature of agency theory is separation of ownership and
control. The theory prescribes that people or employees are held accountable
in their tasks and responsibilities. Rewards and Punishments can be used to
correct the priorities of agents.Various proponents of agency theory have
proposed ways to resolve disputes between agents and principals. This is
termed "reducing agency loss." Agency loss is the amount that the principal
contends was lost due to the agent acting contrary to the principal's interests.
Chief among these strategies is the offering of incentives to corporate
managers to maximize the profits of their principals. The stock options
awarded to company executives have their origin in agency theory. These
incentives seek a way to optimize the relationship between principals and
agents.
● Stakeholder theory -
Edward Freeman’s stakeholder theory holds that a company’s stakeholders
include just about anyone affected by the company and its workings. That
view is in opposition to the long-held shareholder theory proposed by
economist Milton Friedman that in capitalism, the only stakeholders a
company should care about are its shareholders - and thus, its bottom line.
Friedman’s view is that companies are compelled to make a profit, to satisfy
their shareholders, and to continue positive growth.
By contrast, Dr. Freeman suggests that a company’s stakeholders are "those
groups without whose support the organization would cease to exist." These
groups would include customers, employees, suppliers, political action
groups, environmental groups, local communities, the media, financial
institutions, governmental groups, and more. This view paints the corporate
environment as an ecosystem of related groups, all of whom need to be
considered and satisfied to keep the company healthy and successful in the
long term.
The company has to be transparent about how they have considered the
needs and interests of employees, suppliers, factory workers, local
neighbors, and everyone else. Creating this healthy ecosystem is needed for
the company to truly succeed in the long term. If a company cuts corners
with any of these stakeholders, it isn’t going to work out over the long
haul.The effective use of stakeholder theory also yields good public
relations. If the condo-building company builds a park for the local
neighbors, and cleans up a nearby creek that’s an important watershed in the
area, the entire city will have a much more favorable view of the company,
paving the way for long-term future success.
● Stewardship Theory -
A steward is defined as someone who protects and takes care of the needs of
others. Under the stewardship theory, company executives protect the
interests of the owners or shareholders and make decisions on their behalf. It
could be considered as the opposite of agency theory since managers are
considered to work for the benefit of the firm instead of acting for their own
self-interest.
Their sole objective is to create and maintain a successful organization so the
shareholders prosper. Firms that embrace stewardship place the CEO and
Chairman responsibilities under one executive, with a board composed
mostly of in-house members.This allows for intimate knowledge of
organizational operation and a deep commitment to success.
This theory has a clear objective of shareholder satisfaction. Having a single
leader creates one channel to communicate business needs to the
shareholders and the shareholders’ needs to the business. This also avoids
confusion as to who is in charge when a company needs to weather a storm.
Stewardship governance requires that a CEO be trustworthy and willing to
put personal gains aside for the good of the organization.
The relevance of stewardship theory to corporate governance is that the
manager needs to have a clear and unambiguous role. The organizational
structure should allow managers to have acceptable authority, worth and
power. The manager is referred to as a company man who will be committed
and pace the firm ahead of his/her self-interests. This eventually works in the
best interest of everyone.
● Resource Dependence Theory -
Whilst, the stakeholder theory focuses on relationships with many groups for
individual benefits, resource dependency theory concentrates on the role of
board directors in providing access to resources needed by the firm.
Resource dependence is when one organization has to rely on another
organization for a resource. These resources can be for things as obvious as
financing or as subtle as recognition. Through this resource dependence the
organization with the resources is given influence and power over the
organization without the resource. With this influence over others,
organizations can do things such as influence prices and encourage particular
organizational structures.
However, for this to happen there must be few places where the resource
dependent organization can acquire the resource and the resource must be
valuable to the dependent organization.
For example: An organic grocery store can only purchase organic tomatoes
from one local farm. Because the farm knows it is the only local source of
organic tomatoes, it pressures the organic grocery story to also sell their bell
peppers. The organic grocery store decides to sell the bell peppers even
though they are more expensive than organic bell peppers from other farms
because they need to sell tomatoes in their store.
An organization can form a wide variety of buffering or bridging maneuvers
used to overcome persistent dependencies in the environment. For example,
when a company merges with another company it's often a means of
absorbing dependencies and acquiring a degree of autonomy in the
environment. Managers of resource dependence actively seek ways to render
other firms dependent on them, but not vice versa. So, with resource
dependence theory, we have an egocentric view of an organization trying to
acquire the best exchange relations it can within an environment of potential
partners.
