CHAPTER FIVE

PRINCIPLE AND THEORIES OF CORPORATE GOVERNANCE

5.1. Principles of Corporate Governance
Corporate governance is the system by which businesses are directed and controlled. Good
corporate governance is a key factor in underpinning the integrity and efficiency of a company.
Poor corporate governance can weaken a company’s potential, can lead to financial difficulties
and in some cases can cause long-term damage to a company’s reputation.
The fundamental principles of good corporate governance revolve around three basic inter-
related segments. These are:
• Equality/Fairness
• Accountability
• Transparency
• Responsibility
• Fairness
Fairness is defined as just and reasonable treatment in accordance with accepted rules or
principles. Fairness refers to equal treatment. Protecting shareholder rights and ensuring
contracts with resource providers are enforceable. For example, all shareholders should receive
equal consideration for whatever shareholdings they hold. In addition to shareholders, there
should also be fairness in the treatment of all stakeholders including employees, communities
and public officials.
Fairness is characterized by equity, respect, justice and stewardship of the shared world, both
among people and in their relations to other living beings.
• Accountability
Accountability refers that Ensuring that management and shareholder interests are kept in
alignment; responsibility, ensuring corporate compliance with laws, regulations and society
norms. Corporate accountability refers to the obligation and responsibility to give an
explanation or reason for the company’s actions and conduct.
Accountability is one requirement of an effective and influential leader in the workplace. It is
defined as taking ownership to ensure responsibilities are achieved as expected. This means that
leaders must clearly understand expectations before making commitments.
Accountability requires a mental shift in the workplace; leaders have to be willing to give up a
followers’ mentality and focus their efforts in a productive way to ensure that they achieve
results.
Accountability is one way to build trust in the workplace. People trust leaders who aren’t quick
to blame others if things don’t go as planned, but who instead take accountability for their role in
the consequences.
Accountability is an assurance that an individual or an organization will be evaluated on their
performance or behavior related to something for which they are responsible
In brief:
• The board should present a balanced and understandable assessment of the company’s
position and prospects;
• The board is responsible for determining the nature and extent of the significant risks it is
willing to take;
• The board should maintain sound risk management and internal control systems;
• The board should establish formal and transparent arrangements for corporate reporting
and risk management and for maintaining an appropriate relationship with the company’s
auditor, and
• The board should communicate with stakeholders at regular intervals, a fair, balanced and
understandable assessment of how the company is achieving its business purpose.
• Responsibility
The Board of Directors is given authority to act on behalf of the company. They should
therefore accept full responsibility for the powers that it is given and the authority that it
exercises. The Board of Directors is responsible for overseeing the management of the business,
affairs of the company, appointing the chief executive and monitoring the performance of the
company. In doing so, it is required to act in the best interests of the company. Accountability
goes hand in hand with responsibility. The Board of Directors should be made accountable to
the shareholders for the way in which the company has carried out its responsibilities.
Responsibility relates to tasks and projects. Being responsible for something means that it's your
duty to carry out the related tasks. More than one person can share a responsibility, such a team
being collectively responsible for the implementation of a project or handling a situation.
Responsibility is therefore often tied to a required outcome, such as the completion of a
particular task or series of tasks. 
የዳይሬክተሮች ቦርድ ኩባንያውን ወክሎ እንዲሰራ ስልጣን ተሰጥቶታል። ስለዚህ ለተሰጣቸው ሥልጣንና
ለሚሠራው ሥልጣን ሙሉ ኃላፊነት መቀበል አለባቸው። የዳይሬክተሮች ቦርድ የንግዱን አስተዳደር ፣
የኩባንያውን ጉዳዮች የመቆጣጠር ፣ ዋና ሥራ አስፈፃሚን የመሾም እና የድርጅቱን አፈፃፀም የመቆጣጠር
ሃላፊነት አለበት። ይህን ሲያደርጉ የኩባንያውን ጥቅም ማስጠበቅ ይጠበቅበታል። ተጠያቂነት ከሃላፊነት ጋር
አብሮ ይሄዳል። ድርጅቱ ኃላፊነቱን በተወጣበት መንገድ የዳይሬክተሮች ቦርድ ተጠሪነቱ ለባለ አክሲዮኖች
መሆን አለበት።
ኃላፊነት ከተግባሮች እና ፕሮጀክቶች ጋር ይዛመዳል. ለአንድ ነገር ተጠያቂ መሆን ማለት ተዛማጅ ተግባራትን
ማከናወን የእርስዎ ግዴታ ነው. ከአንድ በላይ ሰው ኃላፊነትን ሊጋራ ይችላል፣እንዲህ ዓይነቱ ቡድን ለፕሮጀክት
ትግበራ ወይም ሁኔታን ለማስተናገድ በጋራ ተጠያቂ ነው። ስለዚህ ሃላፊነት ብዙውን ጊዜ ከሚፈለገው ውጤት
ጋር የተቆራኘ ነው, ለምሳሌ አንድ የተወሰነ ተግባር ወይም ተከታታይ ስራዎችን ማጠናቀቅ.
ACCOUNTABILITY VS RESPONSIBILITY
Responsibility refers to the obligation to perform the task or comply with the rule; accountability
implies answerability for the outcome of the task or process.
Responsibility can be shared. You can work with a team of people to divide responsibilities. On
the other hand, accountability is something that can be specific to an individual depending on
their skill set, role, or strengths.
Responsibility is task-oriented. Every person on a team may be responsible for a given task that
is required to complete a massive project. Accountability is what happens after a situation has
occurred. It is how you respond and take ownership over the results.
ኃላፊነት ተግባሩን ለማከናወን ወይም ደንቡን የማክበር ግዴታን ያመለክታል; ተጠያቂነት ለተግባሩ ወይም
ለሂደቱ ውጤት መልስ መስጠትን ያመለክታል።
ኃላፊነት ሊጋራ ይችላል። ኃላፊነቶችን ለመከፋፈል ከሰዎች ቡድን ጋር መስራት ይችላሉ. በሌላ በኩል፣
ተጠያቂነት ለአንድ ግለሰብ እንደየችሎታ ስብስቡ፣ ሚናው ወይም ጥንካሬው የተለየ ሊሆን የሚችል ነገር
ነው።
ኃላፊነት ተግባር ላይ ያተኮረ ነው። በቡድን ውስጥ ያለ እያንዳንዱ ሰው ግዙፉን ፕሮጀክት ለማጠናቀቅ
ለሚያስፈልገው ተግባር ኃላፊነቱን ሊወስድ ይችላል። ተጠያቂነት አንድ ሁኔታ ከተከሰተ በኋላ የሚከሰት ነው.
እርስዎ ምላሽ የሚሰጡበት እና በውጤቶቹ ላይ ባለቤትነት የሚወስዱበት መንገድ ነው።
Responsibility focuses on defined roles, job descriptions, and processes that must be in place to
achieve a goal. On the contrary, accountability is committed to the successful completion of tasks
assigned to you and being willing to take responsibility for everything that happens as a result of
the actions that were taken
Responsibility relates to the completion of a task, whereas accountability relates to the
subsequent examination of its success, processes and other consequences. A person can be both
responsible and accountable, or only responsible or accountable. Generally, accountability is
reserved for managers, team leaders and other leadership positions that are held responsible
for the consequences of the work they're in charge of. They may also be responsible, but not
necessarily. Individuals who perform supervisory roles, inspections or quality assurance work are
also typically held accountable.
For example, an ongoing task that just needs to be repeated only involves accountability if
someone stops doing it. If your responsibility is to water a plant, you're only going to be held
accountable if you stop watering it. Otherwise, your responsibility is simply being carried out
continuously. Another example would be a team leader who assigns and supervises tasks. They
may not be responsible for the tasks being done, but they are going to be held accountable if the
team doesn't finish a project by the deadline.
• Transparency and Disclosure
A principle of good governance is that stakeholders should be informed about the company’s
activities, what it plans to do in the future and any risks involved in its business strategies.
Transparency means openness, a willingness by the company to provide clear information to
shareholders and other stakeholders. For example, transparency refers to the openness and
willingness to disclose financial performance figures which are truthful and accurate.
Disclosure of material matters concerning the organization’s performance and activities should
be timely and accurate to ensure that all investors have access to clear, factual information
which accurately reflects the financial, social and environmental position of the organization.
Organizations should clarify and make publicly known the roles and responsibilities of the board
and management to provide shareholders with a level of accountability. Transparency ensures
that stakeholders can have confidence in the decision-making and management processes of a
company. The roles and duties of directors must be clearly defined by an organization.
Organizations must implement certain procedures in order to verify and safeguard the integrity of
the organization. An organization must disclose the financial information to investors and
shareholders
Transparency means openness, a willingness by the company to provide clear information to
shareholders and other stakeholders. For example, transparency refers to the openness and
willingness to disclose financial performance figures which are truthful and accurate.
Disclosure of material matters concerning the organization’s performance and activities should
be timely and accurate to ensure that all investors have access to clear, factual information which
accurately reflects the financial, social and environmental position of the organization.
Organizations should clarify and make publicly known the roles and responsibilities of the board
and management to provide shareholders with a level of accountability.
Transparency ensures that stakeholders can have confidence in the decision-making and
management processes of a company.
5.2. Corporate Governance Theories
There are many theories of corporate governance which address the challenge of governance of
firms and companies from time to time .The vital theories in corporate governance are;-
• Agency Theory
• Stakeholder Theory
• Resource Dependency Theory
• Stewardship Theory
• Agency theory
Agency theory defines the relationship between the principals (such as share holders of the
company) and agents (such as Director of the company).According to this theory, the principles
of the company hires the agents to perform works. The principals delegate the work of running
the business to the director or manager who are agents of shareholders. Shareholders expect the
agents to act and make decision in the best interest of principals. On the contrary, it is not
necessary that that agent make decision in the best interest of the principals. The agent may be
succumbed to self interest, opportunistic behavior and fall short of expectation of the principals.
The key feature of agency theory is separation of owner ship and control. The theory prescribed
that peoples or employees are held accountable in their task and responsibilities. Reward and
punishment can be used to correct the priorities of agent.

According to the perspective of agency theory the primary responsibility of the board of
directors is towards the shareholders to ensure maximization of shareholder value. The focus
of agency theory of the principal and agent relationship (for example shareholders and corporate
managers) has created uncertainty due to various information asymmetries. The separation of
ownership from management can lead to managers of firms taking action that may not maximize
shareholder wealth, due to their firm specific knowledge and expertise, which would benefit
them and not the owners.
Arising from the above is the agency problem on how to induce the agent to act in the best
interests of the principal. This result in agency costs for example monitoring costs and
disciplining the agent to prevent abuse. Agency cost is defined as the sum of monitoring
expenditure by the principal to limit the irregular activities of the agent. The agency model
assumes that individuals have access to complete information and investors possess significant
knowledge of whether or not governance activities conform to their preferences and the board
has knowledge of investors’ preferences. Therefore according to the view of the agency
theorists, an efficient market is considered a solution to mitigate the agency problem, which
includes an efficient market for corporate control, management labor and corporate
information.

• Stakeholder theory

The stakeholder theory is a theory of organizational management and business ethics that

accounts for multiple constituencies impacted by business entities like employees, suppliers,
local communities, creditors, and others.
This means that management has a duty of care to the organization, its owners, and to its wider
stakeholders.
Stakeholder theory looks at the relationships between an organization and others in its internal
and external environments. It also looks at how these connections influence how the business
conducts its activities. Think of a stakeholder as a person or group that can affect or be affected
by an organization. Stakeholders can come from inside or outside of the business. Examples
include customers, employees, stockholders, suppliers, non-profit groups, government, and the
local community, among many others.
One of the most important contributors to stakeholder theory is R. Edward Freeman and his
book Strategic Management: A Stakeholder Approach (1984). The core idea of stakeholder
theory is that organizations that manage their stakeholder relationships effectively will survive
longer and perform better than organizations that don't. Freeman suggests that organizations
should develop certain stakeholder competencies. These include:
• Making a commitment to monitor stakeholder interests
• Developing strategies to effectively deal with stakeholders and their concerns
• Dividing and categorizing interests into manageable segments
• Ensuring that organizational functions address the needs of stakeholders
Stakeholder theory incorporated the accountability of management to a board range of
stakeholders. It states that Managers in the organizations have a network of relationship to
serve-this includes the suppliers, employees and business partners.
This theory focuses on managerial decision making and interests of all stakeholders have
intrinsic value, and no set of interests is assumed to dominate the others.

This theory centers on the issues concerning the stakeholders in an institution. It stipulates that a
corporate entity invariably seeks to provide a balance between the interests of its diverse
stakeholders in order to ensure that each interest constituency receives some degree of
satisfaction.

Stakeholders include:
•
• Shareholders
• Employees
• Managers/directors
• Suppliers
• Customers
• Competitors
• The government
• The local community
Stakeholders can be classified as:
• Internal Directors: managers and employees
• Connected Shareholders: lenders, suppliers, customers
• External: Government, local populace, pressure groups, trade unions, non-governmental
organizations, regulatory agencies.
The theory differentiates among stakeholder types as: consubstantial, contractual and contextual
stakeholders. Consubstantial stakeholders are the stakeholders that are essential for the
business’s existence (shareholders and investors, strategic partners, employees). Contractual
stakeholders, as their name indicates, have some kind of a formal contract with the business
(financial institutions, suppliers and sub-contractors, customers). Contextual stakeholders are
representatives of the social and natural systems in which the business operates and play a
fundamental role in obtaining business credibility and, ultimately, the acceptance of their
activities (public administration, local communities, countries and societies, knowledge and
opinion makers)
• Resource Dependency Theory
Resource Dependency Theory focuses on the role of board of directors in providing access to
resource needed by the firm. It states that directors play an important role in providing or
securing essential resource to an organization through their linkage to external environment. The
provision of resource enhances organizational functioning, firms’ performance and its survival.
The directors bring resource to the firms such as information, skills, access to constituents such
as suppliers, buyers, public policy makers, social groups as well as legitimacy. Directors can be
classified in to four categories of insiders, business experts, support specialists and Community
influential’s.
The basic proposition of resource dependence theory is the need for environmental linkages
between the firm and outside resources. In this perspective, directors serve to connect the firm
with external factors by co-opting the resources needed to survive. Thus, boards of directors are
an important mechanism for absorbing critical elements of environmental uncertainty into the
firm. Environmental linkages or network governance could reduce transaction costs associated
with environmental interdependency. The organization’s need to require resources and these
leads to the development of exchange relationships or network governance between
organizations. Further, the uneven distribution of needed resources results in interdependence in
organizational relationships. Several factors would appear to intensify the character of this
dependence, e.g. the importance of the resource(s), the relative shortage of the resource(s) and
the extent to which the resource(s) is concentrated in the environment.
According to the resource dependency rule, the directors bring resources such as information,
skills, key constituents (suppliers, buyers, public policy decision makers, social groups) and
legitimacy that will reduce uncertainty.
Resource dependency theory is based on the principle that an organization, such as a business
firm, must engage in transactions with other actors and organizations in its environment in order
to acquire resources.
Resource dependence theory (RDT) characterizes the corporation as an open system, dependent
on contingencies of the external environment (Pfeffer & Salancik, 1978). According to RDT,
firms engage in collaborations with external stakeholders in order to manage their dependency
on critical resources. It proposes that organizations that lack certain resources will develop
relationships with other organizations with the aim of obtaining those required resources (Ulrich
& Barney, 1984).
Resource dependency theory examines the relationship between organizations and the
resources they need to operate. Resources can take many shapes or forms, including raw
materials, workers, and even funding.
“If you do not interfere in politics, politics will eventually interfere in your life”. In this
quote, Vladimir Lenin describes how everyone is a part of something bigger, and that we rely on
each other. The same can be said for any organization, business, firm, or company that exists and
operate today. One way this is exhibited through a company’s dependence on another
organization for the resources it desires to operate. The idea is referred to as resource
dependency theory.

• Stewardship Theory

This theory means that management is the steward of the assets of the organization and good
governance requires active participation from all members. Management will act primarily as
stewards of the organization.
Stewardship theory is a theory that managers, left on their own, will act as responsible stewards
of the assets they control.
Stewardship theorists assume that given a choice between self-serving behavior and pro-
organizational behavior, a steward will place higher value on cooperation than defection.
Stewards are assumed to be collectivists, pro-organizational, and trustworthy.[1]
Stewardship theory is a framework which argues that people are intrinsically motivated to
work for others or for organizations to accomplish the tasks and responsibilities with which
they have been entrusted.
The stewardship theory states that steward protects and maximizes shareholders wealth through
firm performance. Stewards are company executives and managers working for the shareholders,
protects and make profit for the shareholders. Stewards are satisfied and motivated when
organizational success is attained .It stresses on the position of employees or executives to act
more autonomously so that the shareholders return s are maximized. The employees take
ownership of their jobs and work at them diligently.
In contrast to agency theory, stewardship theory presents a different model of management,
where managers are considered good stewards who will act in the best interest of the owners.
The fundamentals of stewardship theory are based on social psychology, which focuses on the
behavior of executives. The steward’s behavior is pro-organizational and collectivists, and has
higher utility than individualistic self-serving behavior and the steward’s behavior will not depart
from the interest of the organization because the steward seeks to attain the objectives of the
organization. Therefore stewardship theory is an argument put forward in firm performance that
satisfies the requirements of the interested parties resulting in dynamic performance equilibrium
for balanced governance.
Stewardship theory sees a strong relationship between managers and the success of the firm,
and therefore the stewards protect and maximize shareholder wealth through firm
performance. A steward, who improves performance successfully, satisfies most stakeholder
groups in an organization, when these groups have interests that are well served by increasing
organizational wealth. When the position of the CEO and Chairman is held by a single person,
the fate of the organization and the power to determine strategy is the responsibility of a single
person. Thus the focus of stewardship theory is on structures that facilitate and empower
rather than monitor and control. Therefore stewardship theory takes a more relaxed view of the
separation of the role of chairman and CEO, and supports appointment of a single person for the
position of chairman and CEO and a majority of specialist executive directors rather than non-
executive directors.
Examples of Corporate Stewardship
An example of a stewardship model of corporate governance might include a business focused
on environmental concerns, where the company believes it should operate with as little impact
as possible on the earth. The Coca-Cola Company, which uses huge amounts of water for its
products, for example, has committed to being good stewards of water resources.
A sense of stewardship teaches that your business isn't about you. This mindset recognizes
you're really holding the business in trust for some higher principle or a greater good.
Stewardship sets the tone on how you will approach environmental concerns and what you
might do to be a good neighbor. It also drives you to keep the company in good shape for when
the next owner takes over.