Executive Master of Business Administration (EMBA)

MBAE MGT 204: Corporate Governance and Ethics

Topic 2: Corporate Governance Theories
Dr. James Kwan
Ph.D. Finance (UWA), MBA (Strathclyde), MBA Investment & Finance (Hull), MSc Digital Education (Edinburgh),
MSc Educational Assessment (Oxford), MBR (UWA), MSc Applied Positive Psychology & Coaching Psychology
(UEL), MSc Marketing (KCL), MRes Higher Education Research (Lancaster), BAcc (NTU), FCA Singapore, ASEAN CPA,
FCPA (Aust), FAIA (Acad), AMA (Aust), FHEA, CSFP, SDALT, Bok TC (Harvard), CEOT (Oxford), CEOCD (Oxford), ACTA

Corporate Governance:
Theoretical Aspect
• At the heart of the governance dilemma is the
separate legal status of the corporation
• The idea that the corporation is separate from any
individual is central to understanding of corporate
governance
– The separation of ownership and management
• Corporate governance is concerned with the exercise
of power by the corporation — and who to hold
responsible for the exercise of that power
• Theories help us to understand and explain
phenomena
– Through the study of corporate governance we can develop
theories that explain what systems work and provide advice
to directors
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 Corporate Governance:
Theoretical Aspect

There are two major branches of organisational economics:

• Agency theory regards the firm as a series of contractual
relationships between owners and workers

• Transaction costs theorists view the organisation as

a series of transactions
• Both perspectives address how owners try to ensure
that employees, suppliers, and contractors conduct
themselves in a way that will help the organisation
achieve its goals and both discuss governance
mechanisms that can assure economic efficiency
and minimize problems and costs
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Basic Points of Agency Theory

• Organisations: series of contractual relationships
between agents and principals
 Principals: owners (shareholders) of a firm

 Agents: people hired by the owners to run the firm

(managers and workers)

 Agency Costs: costs associated with monitoring agent

behavior and enforcing contracts

 Goal: efficient arrangement (lowest agency costs) of

agent-principal relationships.
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 Basic Points of Transaction Cost Perspective

• Organisations: series of transactions, some within

the Org, some across the Org’s boundaries
 Transaction: exchange of goods and services among
groups within the Org. or across organisational
boundaries
 Transaction Costs: explicit fees or costs
associated with a transaction; implicit costs of
monitoring and controlling a transaction
 Goal: to determine the most efficient arrangement of
transactions — whether transactions should take place
inside the Org or across Orgal boundaries; seek lowest
transaction costs.
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Stakeholder Theory
• Stakeholder Theory is understanding the role of
the firm in the wider context
• It is different to agency theory where the firm
should concentrate solely upon the maximising
shareholder value
• Stakeholder Theory views that other groups have
stakes in a company
• It is viewed that corporations have grown so
large that their influence on society is so large
that they should have some accountability to
many more people in society than just
shareholders

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 Stakeholder Theory
• Focuses less on maintaining and enhancing
shareholder value and more on providing value to all
the company’s stakeholders
• Differences between agency theory and stakeholder
result in different expectations for corporate
governance recommendations and processes
Contrast the Anglo-American system with the German system

• Hybrid stakeholder-agency approaches have

developed recently
• Hybrid approaches emphasise that if shareholders
are to maximise their returns, they need to ensure
they satisfy the company’s various stakeholders

Stakeholder versus Agency

• Can companies maximize shareholder wealth AND
satisfy a broad range of stakeholder needs?
• Problems of balancing needs of stakeholders
• Often different groups have diverse and
contradictory needs and concerns
• There is“an ongoing struggle between economic
views of the firm which are decidedly silent on the
moral implications of the modern corporation, and
ethicists who place the need for understanding
ethical implications in a central role in the field of
business ethics” (Shankman, 1999, p. 319)
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 Stakeholder versus Agency
• Stakeholder theory is the necessary outcome of
agency theory

• Agency theory is at best a narrow form of

stakeholder theory;

• The assumptions about human behaviour and

motivation implicit in agency theory are
contradictory

• All theories of the firm must uphold an implicit

moral minimum that includes certain fundamental
rights 9

Stakeholder versus Agency

• Maximising stakeholder welfare/wealth leads to
long-term value maximisation

• Creating value for stakeholders is synonymous with

creating financial value for shareholders

• Ignoring the needs of stakeholders can lead to lower

financial performance and even corporate failure –
LOOK AT BP and the Gulf of Mexico!

• Corporate social, ethical and environmental

performance are indicators of management quality
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 Approaches to Corporate Governance
• The Rules-Based Approach to Corporate
Governance
– Prescribe precise practices that are
required or recommended to ensure good
corporate governance.
– Associated with enforcement by legislation
or listing rules, with imposition of penalties
if the rules are not followed.
– Example: US Sarbanes Oxley Act

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The Rules-Based Approach to

Corporate Governance
• Advantages
– Provides a set of minimum corporate governance
practices that must be followed by all
corporations.
– Aids enforcement and clarifies potential liability.
• Disadvantages
– Lowest common denominator approach
– Encourages form over substance
– Focus on legal liability not stakeholder interests
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 The Principles-Based Approach to
Corporate Governance
• Identifies general principles or objectives for the
corporate governance system to aim to achieve.

• Responsibility is placed on the managers to consider

which practices are appropriate, given their
circumstances, i.e. “comply or explain”.

• Examples: Singapore, Australia, UK, Hong Kong

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The Principles-Based Approach to

Corporate Governance
• Advantages
– Places a higher level of duty on directors to determine
which corporate governance practices are required.
– Its flexibility means that practices can be adapted for
the particular circumstances and environment of the
entity.
• Disadvantages
– Directors must interpret these principles and decide
which corporate governance practices are needed.
– It relies on their honesty, integrity and commitment to
good governance.
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Practical Considerations
• In most countries, corporate governance
involves various combinations of both the
rules and principles-based approaches.
– Specific legislation that requires certain
corporate governance practices to be
followed by law.
– Codes of corporate governance practice
issued by government or industry groups
and also by stock exchanges.
– Example: Canada

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