Corporate Governance and CSR

Many scandals have happened due to the absence of corporate governance. Shockwaves of this were
experienced by employees…by charities that have relied upon corporate philanthropy. The result of the
scandals has been a distrust of the financial markets.

In whose interests should corporations be governed?

Should corporations be governed only in the interest of shareholders, or in the interest of other
stakeholders as well ? Certainly, the shareholder is a major stakeholder, and corporate governance
systems throughout the world are converging on a shareholder-centric ideology. However, shareholders
are not a homogenous group – they vary in their investment horizons, trust levels and risk preferences.

Institutional investors may embrace concepts of CSR and give importance to stakeholder value
maximization. Thus, shareholders and stakeholders are not always opposing forces.

Underlying assumptions about managers

Shareholders are the principles in corporate governance. They delegate decision-making authority to
managers under the assumption that managers will make decisions and take actions that are in the
shareholders’ best interests. Agency problems arise when the interests of the two diverge, and managers
work in their own self-interest, rather than the interest of the Shareholders. The expectation inherent in
agency theory is that managers will pursue self-interest as opposed to the interests of the shareholders.

Thus, agency and management hegemony theories depict managers as self-interest maximizing and in
need of strong controls. While agency theory focuses on the actions managers will take that are not in
the shareholder’s interests, managerial hegemony theory focuses upon the control managers can have
over the Board and how that can enable managers to maximize their own self interest, at the cost of
shareholder and stakeholder interest. This control of managers over the Board is inappropriate since the
Board hires and fires managers and should not be controlled by it.

Stewardship theory offers an alternative depiction of the nature of managers. This theory adopts a
different model of man and proposes that man can be collectivist, pro-organizational and trustworthy.
The S theory is a complement to the agency theory. It does not say that the agency theory is wrong, only
that it is incomplete and the assumptions about the manager as a self-interest maximizing individual will
not always hold.

Board Composition and Structure

Board composition is important for its role in providing governance guidelines as well as in financial and
social performance.

Let us see how the different theories regard Board – Management theory

Agency theory - there are potential conflict of interest in the battle for control between management
and the board.

Stewardship theory, the Board is collaborative with the management

 Circulation of power theory – Board -CEO relationships change over time due to political and technical
contestations

Social network theory – discusses the impact of CEO-Board social ties

With these theory approaches to understand the role of board composition and structure, it is clear that
board composition and structure have considerable potential for impact on the social responsibility and
responsiveness of the firm.

Board structure comprises the following.

Size of the Board and division of labour between the Board and CEO

Ratio of outside to inside directors

Demographic and relational characteristics of Board members, including occupation, tenure, gender,
race, functional background, educational background, etc.

Effect of Board composition on different factors

Effect on Firm’s financial performance –

A review of the relationship between board composition and financial performance showed that there is
little evidence of a relationship between the 2.

Effect on Executive compensation, CEO turnover, Corporate strategy, etc.

CEO duality (when the CEO is also the board chair) is another issue that has received attention from
corporate governance researchers. In such a case, the CEO would have undue power over the Board,
thus robbing the Board of its monitoring function. From an agency theory standpoint, CEO duality
increases the likelihood that agency problems will arise, because the board is not likely to restrain its
chair from pursuing self-interest. In spite of these concerns, CEO duality has its positive aspects. 1.
Duality provides a unity of command that can enable CEOs to act quickly and decisively. However,
empirical studies have not led to any consistent conclusions about the impact of duality. This may mean
that there is evidence for both agency and stewardship arguments and the integration of the 2
perspectives would provide a deeper understanding of CEO duality and the issues it presents. This
argument is consistent with stewardship’s theory’s contention that managers are not necessarily self-
interest-maximizing agents nor are they always stewards; people vary in their situations and motivations
depending on the contingencies involved.

Are there any links between characteristics of the Board and the firms’s other forms of social
responsibility ?

The following have been noticed.

People dimension of CSR, which incorporates women and minorities, employee relation issues etc., was
positively associated with outside director representation. Outside directors also positively impacted
product quality dimension, which includes the environment. Studies have shown that boards which are
dominated by insiders were more likely to be the subject of suits, even more so if the CEO held the
position of board chair.

Is there any relationship between the composition of Board and its level of giving (corporate
philantrophy)

Studies have shown a positive relationship between inside directors and corporate philanthropy; CP is
also positively related to women and minority representation on the board. In contrast, other scholars
found that outside directors in the service industry exhibited greater concern for the discretionary
component of social responsibility. Presence of women on the Board had a positive impact in the areas
of community service and the arts, but not in education or public policy issues.

Stock ownership

Studies have found long-term institutional ownership to be associated positively with corporate social
performance. Another parameter is CEO or an individual owning a significant amount of stock in the
company – it this case, the firm contributed less to CP.

Board Diversity

Homogenous boards run the risk of falling prey to group think and failing to challenge the assumptions
underlying their decisions. In theory, diverse boards should have the range of experiences necessary to
understand the needs of diverse stakeholders. However, scholars point out that substantive change will
have to occur before the goal of board diversity is achieved, because the current design of board
elections results in a self-perpetrating homogenous board.

Corporate Democracy

Corporate Democracy

Shareholders are the owners of the company and have ultimate control over the company. Being
owners, they have the right to select the Board of Directors and voice concerns regarding corporate
governance. The Board then has the responsibility to see that managers act in best interest of
shareholders. Lets see whether this is happening in practice.

There are many obstacles being faced which are discussed below.

Obstacles on the path of Corporate Democracy / Board Democracy

Shareholders do not have an actual right in participation. For example, Boards in the US an ignore
shareholder resolutions about executive pay and votes against board candidates are not counted. Only
the votes actually cast for board members is counted, and so, withholding a vote has no consequence.
Moreover, even the system of proxy voting has its shortcomings. The process of proxy voting is supposed
to guarantee that shareholder preferences are respected because the agent designated to vote the
proxies is required to follow the wishes of the shareholders. However, the process of soliciting proxy
votes is expensive and these expenses are covered by the corporation; this leaves shareholders with a
slate chosen by the board and a board that is, in effect, electing itself.

Classified Boards (boards with members that serve staggered terms)

In this Board, only a fraction of board members are elected in any given year. Shareholder advocates
have called increasingly for the de-classification of classified boards. From this perspective, unitary
boards (wherein each board member is up for election each year and members are elected to one-year
terms) provide shareholders with greater redress of grievances that arise. By being able to vote on each
board member each year, shareholders are better able to express their views in decisions that impact
their own wealth.

In contrast, advocates of classified boards contend that directors need a certain level of autonomy to
exercise sound business judgment on the many difficult issues that boards face. They feel that giving
shareholders the option of replacing each board member each year will only slow down decisions that
must be made quickly to maintain competitiveness. They argue that shareholders are not infallible and
the shareholder push for short-term returns has been part of the problem. From this perspective, de-
classification will promote a short-term perspective and break the continuity important for success in
today’s competitive environment.