Unit 5 Corporate Governance (CG)

Concept
Corporate Governance refer to the method by which a firm is being governed, directed,
administered or controlled towards the goal. CG is defined as a frame of legislations, rules and
regulations through which company can improve its financial performance in a more clear way.
Corporate governance is generally perceived as a set of codes and guidelines to be followed by
companies. It involves relationships between a company’s management, its board, shareholders and
other stakeholder.
Scope of Corporate Governance
1. Accountability: Corporate Governance is concerned with the relative roles, right and
accountability of stakeholders.
2. Transparency: Right of information, timeliness, and integrity of the information
provided.
3. Clarity in responsibility: Corporate governance clarifies the role of each stakeholders.
4. Quality and competency of director: CG helps to assess the Quality and competency of
director with their track record.
5. Check and balances: In the process of governance, CD helps to check the operation of
the organization and help to balance with the goal.
6. Adherences (rules, law, spirit of codes)
7. Corporate Fairness: Corporate fairness can be achieved through CG
8. Relative rules and right
Significance of CG
Corporate Governance is significant to fight effectively with the corruption and abuses of the power that
are existed in Nepalese society and help to establish the system of managerial competence and
accountability.
1. To aligning(bring into line) corporate goals
2. Best interest of all
3. Strengthen corporate functioning
4. Discourage mismanagement
5. Ensure corporate success and economic growth
6. Specify responsibility of the BOD
7. Specify responsibility of the manager for ensuring good CG
8. Good corporate governance also minimize wastage, corruption, risks and mismanagement
9. Help in brand formation and development
10. Strong CG maintains investors’ confidence
11. Positive impact on the share price
 Theories of CG
1. Agency theory
Agency theory explains about relationship between principal and agent. Agency theory identifies the
agency relationship where one party (principal) delegates work to another party (agent). In the
context of a corporation the owner are the principal and the directors are the agent.
Here, the different interests of principal and agents may become a source
of conflict as some agents may not perfectly act in the principal best interest. The resulting
miscommunication and disagreement may result in a various problems within companies such as
inefficiencies and financial losses. This leads to the principal-agent problem. (Here owner are
principal and director are agent)

Conflict

Goal orientation
Principle Risk Agent
Self-interest

Congruence

2. Stewardship Theory
Steward theory proposes that managers are essentially trustworthy individual or good steward
(agent) of the resources entrusted to them. The stewardship theory assumes that managers are
trustworthy and attach significant value to their own personal reputations.
It defines situation in which managers are stewards whose
motivations are associated with the objectives of their principals. A steward behavior will not
departs/divert from the interest of their organization. Stewardship maintain that managers
naturally work to maximize profit and shareholder.

3. Transaction Cost Theory

This concept is based on the fact that firm have become so large and complex that they substitute
for the market in determining the allocation of resources. Actually, companies are so large and
complex that price movement outside companies direct the production and market coordinate the
transaction.
It is in the interest of the company management to internalize transaction as
much as possible. The main reason for this is that such internalization removes risk and
uncertainties about future products price and quality. So manager must organize transaction in
their best interest and activity need to be controlled, so organization should not be opportunist.
Governance of Corporate Entities
1. Separation of Ownership and Managerial Control: Shareholder make investment by purchasing
stock (representing ownership), which entitles them to a share of the firm’s residual income (or
profit) that remain after all expenses have been paid.
i. Right to share in income and also shareholder also has to accept the risk.
ii. Shareholder can manage investment risk by investing in a diversified portfolio of firms.
2. Agency Relationship
Agency relationship exists when one party (principal) delegate decision making to another party (agent)
in return for compensation.
3. BOD: BOD is a representative of the shareholder of the organization.
4. Executive Compensation: It is a mechanism that seeks to align managers and owners interest
through salary, bonus and long term incentive compensation such as stock options.

Challenges for Good Corporate Governance (Nepal)

1. Political instability
Frequently changed government and different political unrest brings different challenge for
good corporate governance.
2. Lack of training in corporate Governance
3. Lack of institutional capacity for enforcement of law and regulation
4. Unethical practices
5. Role differentiation
6. Lack of law and regulation
7. Misunderstanding
8. Corruption
9. Dominance of family business
10. High concentration of corporate ownership structure
11. Absence of political and leadership will
12. Favoritism

Impact of Corporate Governance

Corporate Governance brings many benefits and impact to the society, which are as follows:
1. Uplift the society
2. Prevent corruption
3. Attract potential investor
4. Public faith
5. Confidence in the political environment
6. Effective utilization of limited resource
7. Help to promote the welfare in the society
8. Strategic business reason (mergers and acquisition)
9. Improve the performance the individual player

End of the chapter