Part 2

1.)Theories Influencing the Development of Corporate Governance

Several theories have shaped the evolution of corporate governance, each

addressing various aspects of organizational control, accountability, and

stakeholder relationships:

1.Agency Theory:

The agency theory is one of the most influential in corporate governance. It

suggests a potential conflict of interest between the principals (owners or

shareholders) and agents (managers or executives). Since agents may act in

their own interest rather than in the best interest of the principals,

mechanisms like board oversight, performance-based compensation, and

audits have been introduced to align interests.

2.Stewardship Theory:

Contrary to agency theory, stewardship theory assumes that managers,

when empowered, will act as stewards of the company, aligning their

organizational success. This theory suggests that governance mechanisms

should focus on trust and empowerment rather than excessive monitoring.

3.Stakeholder Theory:

Stakeholder theory broadens the focus of corporate governance by

considering the interests of all stakeholders, not just shareholders. This

includes employees, customers, suppliers, and the broader community.

Governance systems are expected to balance these diverse interests,

emphasizing corporate social responsibility (CSR).

4.Resource Dependence Theory:

This theory views boards of directors as a mechanism for managing

external dependencies, such as access to resources or networks. Corporate

governance, from this perspective, is about ensuring that a company’s

leadership can secure the resources and support necessary for growth.

5.Transaction Cost Economics:

Transaction cost economics theory suggests that governance structures

should minimize the costs of exchanges within and outside the

organization. This view influences the design of contracts, ownership

opportunism.

2.)Applicability of Theories to Different Ownership Structures

Different governance theories may be more appropriate depending on the

ownership structure of the firm:

•Publicly Traded Companies: For large, dispersed ownership in public

companies, agency theory is often more relevant. Shareholders in these

companies are typically not involved in day-to-day management, so

mechanisms to monitor and control agents (executives) become crucial.

•Family-Owned Firms: In family-owned businesses, stewardship theory

may be more applicable, as family members tend to have a stronger

alignment with the company’s long-term goals. Trust-based governance

may be more effective than external monitoring.

•State-Owned Enterprises: For state-owned enterprises, a blend of

stakeholder and resource dependence theories may be relevant. These

entities often have to balance economic goals with public interest,

requiring governance systems that consider diverse stakeholder needs

sector.

3.) Principal-Agent Relationship Problems and Solutions

The principal-agent relationship can result in several problems:

1.Moral Hazard: Agents (managers) may take risks knowing that the

consequences will primarily affect the principals (shareholders). For

example, executives may pursue short-term profit at the expense of long-

term stability to secure bonuses or stock options.

2.Adverse Selection: Principals may not have enough information about the

agents’ true competencies or intentions, leading to the selection of under-

performing or opportunistic managers.

3.Information Asymmetry: Managers typically have more access to

information about the company’s operations and performance than

shareholders, which may lead to insider trading or the concealment of

negative information.

4.Managerial Opportunism: Managers may make decisions that benefit

them personally, such as excessive compensation or entrenchment

strategies that prevent their removal, even when the company is under-

performing.
Solutions

•Performance-based Incentives: Aligning compensation with long-term

performance (e.g., stock options with vesting periods) helps align

managerial interests with shareholders.

•Board Oversight: A strong, independent board can provide effective

oversight of management, ensuring that their actions align with

shareholder interests.

•Transparency and Reporting: Enhanced disclosure requirements and

regular reporting reduce information asymmetry, helping shareholders

monitor managerial behavior.

•Corporate Governance Codes: Adherence to governance codes, such as

the UK Corporate Governance Code or SOX (Sarbanes-Oxley) in the U.S.,

can ensure that companies implement best practices in governance.

4.)Impact of the Global Financial Crisis on Convergence of Corporate

Governance Systems

The global financial crisis (GFC) of 2007-2008 exposed significant

weaknesses in corporate governance, particularly in financial institutions.

Before the crisis, there was a growing trend towards the convergence of
corporate governance systems globally, with many countries adopting

Anglo-American practices focused on shareholder value.

Post-GFC Impact:

1.Increased Regulation: The crisis led to a push for stricter regulation in

corporate governance, particularly in the financial sector. Countries

introduced reforms like Dodd-Frank Act in the U.S. and similar measures in

Europe, aiming to strengthen board oversight, risk management, and

accountability.

2.Shift Towards Stakeholder Governance: The GFC highlighted the dangers

of an exclusive focus on shareholder value, prompting a shift towards

stakeholder governance. Companies, especially in Europe, began adopting

more inclusive governance systems that consider environmental, social,

and governance (ESG) factors.

3.Resistance to Convergence: While convergence was a dominant trend

before the crisis, post-GFC, many countries have emphasized the need for

locally appropriate governance models. The U.S., for instance, retained a

strong shareholder-centric model, while countries like Germany maintained

their co-determination practices that involve employee participation in

governance.
5.) Role of Corporate Culture in Ensuring an Ethical Environment

Corporate culture plays a critical role in shaping the ethical environment of

an organization:

1.Encouraging Integrity: A strong ethical corporate culture promotes

integrity among directors and employees. When ethical values are

embedded in the organizational culture, individuals are more likely to act

responsibly, even when external oversight is limited.

2.Setting the Tone from the Top: Corporate culture often stems from

leadership. If directors and executives demonstrate ethical behavior, this

sets a standard for the rest of the company, fostering a culture of

compliance and ethics.

3.Whistle-blowing Mechanisms: An ethical culture encourages whistle-

blowing by providing safe channels for employees to report unethical

behavior without fear of retaliation. This promotes accountability at all

levels.

4.Code of Ethics: Implementing a clear and enforceable code of ethics can

help employees and directors navigate complex situations where ethical

dilemmas may arise, promoting transparency and fairness.

How Corporate Culture Encourages Ethical Behavior

understand the company’s values and the importance of integrity in their

actions.

•Rewarding Ethical Behavior: By recognizing and rewarding ethical

behavior, companies can incentivize directors and employees to make

decisions that align with the company’s ethical standards.

•Consistent Enforcement of Policies: Companies must ensure that ethical

policies are consistently enforced across all levels, which strengthens the

culture of integrity and deters misconduct.

Conclusion

Corporate governance is influenced by multiple theories, each emphasizing

different aspects of control, accountability, and stakeholder relationships.

Theories like agency theory may be more relevant for publicly traded firms,

while stewardship theory might apply to family-owned businesses. The

principal-agent problem introduces challenges like moral hazard and

information asymmetry, which can be mitigated through performance-

based incentives and board oversight.

leading to increased regulation and a shift towards more stakeholder-

focused models. Corporate culture plays an essential role in ensuring an

ethical environment, where directors and employees are encouraged to act

with integrity, contributing to long-term corporate success.