CORPORATE GOVERNANCE

Theories of Corporate Governance

• Agency theory
• Stewardship theory
• Shareholders Vs stakeholders theory
• Transaction cost theory
• Sociological theory

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 Theories of Corporate Governance (contd)
• Agency theory
• The economic relationship that arises
between two individuals
• Principal
• Agent
• Three conditions to operate relationship
• The agent has the freedom to choose
between various course of actions
• Actions of agent influence their own
growth as well as the principals
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• Difficult for the principal to observe
the actions of the agent as
information is not enough
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 Theories of Corporate Governance (contd)
• Agency theory
• The supplier of finance need return on
their investment
• Principal needs assurance that agent
does not steal the investment
• Principal needs to control the agent
• Control is dispersed and less effective
• Problems with agency theory
• Utility maximizer (agent will not act in
the best interest of the principal
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• Unequal sharing of information
• Element of risk (judge performance
based on annual reports )
 Corporate Social Responsibility

Theories of Corporate Governance (contd)

• Agency theory
• Agency loss
• How to reduce it
• Focuses on quantitative and not
qualitative aspect
• To overcome the problems mentioned above:

• Transparent accounting practices and

disclosure
• Non executive independent directors
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 Corporate Social Responsibility

Stewardship Theory
• Built on premise that directors will fulfill their duties
towards the shareholders
• Assumes that human are good and directors are
trustworthy
• Directors are stewards whose motives are aligned with the
objectives of the principles
• Directors take in to account the stake holders but after the
shareholders
• Strengths
• Trust is high and stewards are motivated
• New ideas and growth
• More liberal and believes in empowerment
• Weaknesses
7 • Causal relationship between governance and
performance cannot be assessed using this theory
 Corporate Social Responsibility

Transaction Theory
• Assumes that managers seek self interest
• Managers operate under bounded
rationality
• Selfishly driven to undertake transaction
that benefits them personally
• Make transaction without study as the
money invested is not their own
• Strengths / weaknesses
• Quantification is easy
• Shareholders are residual receivers ,
8 concern about safety of investment
 Corporate Social Responsibility

The sociological theory

• Composition of the board, transparency of
the financial reporting, disclosure and
auditing are considered central to realizing
the socio economic objectives
• Strengths / weaknesses
• Based on fair distribution of wealth in
society
• The challenge is that the board should
not have absolute powers
• Government control, interference
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may increase leading to constraints
and red tape
 Corporate Social Responsibility
Importance of CSR in corporate governance
• Stakeholders theory is integral to corporate
governance in addition to shareholders value
• General acceptance that government cannot mange
all needs of society and companies have to involve
themselves for the welfare of stakeholders
• Corporations have the following responsibility
• Economic
• Legal
• Ethical
• Honor trust
• Be culture sensitive to provide the right
services
10 • Discretionary
• Undertake voluntary activities and
expenses, keeping the greater good of
society in mind