DEVELOPMENTS IN

CORPORATE
GOVERNANCE
DEVELOPMENTS IN CORPORATE
GOVERNANCE
INTRODUCTION

‘‘Corporate governance broadly refers to the mechanism,

relations, and processes by which a corporation is
controlled & is directed.’’
DEVELOPMENTS IN CORPORATE
GOVERNANCE
WHY CORPORATE GOVERNANCE
‘‘The need of for corporate governance has arisen because
of the increasing concern about the non-compliance of
standards of financial reporting and accountability by board
of directors & management of corporate inflicting heavy
losses on investors’’
 DEVELOPMENTS IN CORPORATE
GOVERNANCE
THEORIES OF CORPORATE GOVERNANCE
• Agency theory
• Separation of ownership & control
• Transaction cost economics
• Stakeholder theory
• Stewardship theory
DEVELOPMENTS IN CORPORATE
GOVERNANCE
WHY CORPORATE GOVERNANCE THEORIES
Corporate governance theories are for us to understand the
relationship between fraud, earnings management, corporate
governance and firm performance
AGENCY THEORY
DEVELOPMENTS IN CORPORATE
GOVERNANCE
AGENCY THEORY

Agency theory is the explanation of the dynamics that occur in the

relationship between principle & agent and especially offers an explanation for
what happens when there is a problem or conflict in goals that arises between
the principal and the agent.
Agency theory is also concerned with resolving problems that can exist in
agency relationships.
DEVELOPMENTS IN CORPORATE
GOVERNANCE
DEVELOPMENTS IN CORPORATE
GOVERNANCE
EXAMPLE
Jim uses a financial advisor to take care of his investing and savings accounts
because he does not have time to manage his finances. Jim's advisor acts and
makes decisions on Jim's behalf when it comes to his finances. While Jim gives
the financial advisor permission to make decisions, the two of them may have
different mindsets when it comes to risk, and they may both have different ideas
about what kind of gain is the best.
DEVELOPMENTS IN CORPORATE
GOVERNANCE
The conflict arises due to 2 reasons

1. Self interest

2. Asymmetry of information
DEVELOPMENTS IN CORPORATE
GOVERNANCE
SOLUTION TO AGENCY PROBLEM
• Incentivizing Employees
• Monitoring Function / Shareholder control & interference
• Threat of dismissal
• Threat of take-overs
SEPARATION OF
OWNERSHIP &
CONTROL
SEPARATION OF OWNERSHIP
& CONTROL
• Introduction
• Small firms’ managers are high percentage owners, which implies less separation between
ownership and control
• Usually implies family-owned businesses, this group faces 2 critical issues:

1. As they grow, they may not have access to all needed skills to manage the growing firm and
maximize its returns, so may need outsiders to improve management
2. May need to seek outside capital (whereby they give up some ownership control)
 SEPARATION OF
OWNERSHIP & CONTROL
• Agency Relationships:

– Relationships between business owners (principals) and decision-making

specialists (agents) hired to manage principals' operations and maximize
returns on investment

– Other agency relationship examples: Consultants/clients; insured/insurer;

manager/employee
 SEPARATION OF
OWNERSHIP & CONTROL

• Agency relationships (Cont’d)

– Managerial Opportunism: Seeking self-interest with guile Opportunism: an
attitude and set of behaviors

– Managers don’t know which agents will enact managerial opportunism

– Principals establish governance and control mechanisms to prevent agents

from acting opportunistically
SEPARATION OF OWNERSHIP
& CONTROL
• Agency problems: Product diversification

– Can result in 2 manager benefits shareholders “don’t enjoy”

• Increase in firm size
• Firm portfolio diversification which can reduce top executives’ employment risk (i.e., job
loss, loss of compensation and loss of managerial reputation)

– Diversification reduces these risks because a firm and its managers are less
vulnerable to the reduction in demand associated with a single or limited number
of product lines or businesses
SEPARATION OF OWNERSHIP
& CONTROL
• Agency problems: Firm’s free cash flow

– Resources remaining after the firm has invested in all projects that have
positive net present values within its current businesses
– Available cash flows
• Managerial inclination to over diversify can be acted upon
• Shareholders may prefer distribution as dividends, so they can control how the cash is invested
SEPARATION OF OWNERSHIP
& CONTROL
• Agency costs and governance mechanisms

– Sum of incentive costs, monitoring costs, enforcement costs, and individual

financial losses incurred by principals, because governance mechanisms
cannot guarantee total compliance by the agent
• Costs associated with agency relationships, and effective governance mechanisms should be employed to
improve managerial decision making and strategic effectiveness
• Sarbanes-Oxley Act
TRANSACTION
COST
ECONOMICS
TRANSACTION COST ECONOMICS

• TCE views firm as the governance structure whereas the agency theory views
the firm as the nexus of contracts. Essentially, the latter means that there is
good connected group or series of contract among the various players, arising
because it is seemingly impossible to have a contract that perfectly aligns the
interest of principal and the agent in the corporate control situation.
TRANSACTION COST ECONOMICS

Transactions Can Be Internal or External to an Organization

• Transactions occur whenever a good or service is transferred from a
provider to a user

• Transaction costs depend on how the transaction is organized, i.e., the

governance structure − Within an organization, costs include managing and
monitoring personnel and procuring inputs − When buying from an
external provider, costs can include source selection, contract
TRANSACTION COST ECONOMICS

The Air Force Has Many Options for Organizing Transactions

Spectrum of Governance Structures

Spot market- Simple Short term contracts- Long term contracts- Relational Contracts- Vertical
Integration

Examples,
Gasoline, paper, milk- Custom, Stationary delivery- Power by the hour maintenance- Major
weapon system acquisition- Organic Provision, inter-service support
TRANSACTION COST ECONOMICS

Characteristics of Transactions can affect Transaction Costs:

• Investments in transaction-specific assets improve the efficiency of some transactions.
− Site specificity
− Specialized equipment or tooling
− Specific skills or knowledge
− Dedicated capacity
− Brand name or reputation
• If parties behave opportunistically, they can capture the value of investments made by others.
• Bounded rationality limits the ability of both managers and contracts to control incentives
STAKEHOLDER
THEORY
INTRODUCTION TO STAKEHOLDER THEORY:

• Stakeholder theory is an idea that businesses should not

function only for financial benefit; they should run for the
benefit of both their owners and stakeholders.
• Corporations are not simply managed in the interests of
their shareholders alone, but that there are a whole range of
stakeholders.
• Corporations are not simply managed in the interests of
their shareholders alone, but that there are a whole range
of stakeholders.

• It identifies and models the groups, which are stakeholders

of a corporation and both describes and recommends
various methods to satisfy them.

• Ethical organization recognizes its responsibilities towards

all stakeholders.
There are two types of stakeholders:

INTERNAL
STAKEHOLDERS

EXTERNAL
STAKEHOLDRS
INTERNAL STAKEHOLDERS

SHAREHOLDERS

EMPLOYEES

MANAGEMENT
RESPONSIBILITY TOWARDS
OWNERS/SHAREHOLDERS
• Proper use of capital

• To manage business effectively

• To provide accurate and timely information

• Provide regular and fair return on owners capital

RESPONSIBILITY TOWARDS
EMPLOYEES
• Fair compensation for service provided
• Timely and regular payments
• Provision of proper working and welfare conditions
• Training and development opportunities
• Fair and unbiased treatment to all
RESPONSIBILITY TOWARDS
MANAGEMENT

• Management decisions have impact

• Shareholder’s expects higher returns

EXTERNAL STAKEHOLDERS
Customers

Suppliers

Creditors

Competitors

Government

society
RESPONSIBILITY TOWARDS
CUSTOMERS
• Ensuring consistent quality
• Providing ease-to-use products
• Increasing customer satisfaction
• Responding to product-related issues
RESPONSIBILITIES TOWARDS
SUPPLIERS
• Giving regular orders
• Timely payment of dues
• Helping suppliers in improving or
• upgrading the quality
RESPONSIBILITIES TOWARDS
INVESTORS/CREDITORS
• To provide fair returns on capital invested

• To supply complete and accurate information

• To raise public image of the company

RESPONSIBILITIES TOWARDS
COMPETITORS:

• Not to offer too high discounts to the consumers

• Not to defame competitors directly or indirectly

 RESPONSIBILITIES TOWARDS
SOCIETY AND GOVERMENT
TOWARDS SOCIETY TOWARDS GOVERMENT

• Efficient use of resources • Payment of taxes

• Protection of environment • Obeying rules and regulations
CONCLUSION

Thus , ethical organization is the one that

recognizes its responsibilities towards all
stakeholders and considers their interest
when taking decisions.
STEWARDSHIP
THEORY
STEWARDSHIP THEORY

“Stewardship theory is a theory that

managers, left on their own, will act as
responsible stewards of the assets they
control”.
• A “Steward” is defined as someone who
protects and takes care of the needs of others.

• Stewardship Theory sees managers as good

stewards who acts in the best interest of the
owners (Shareholders).
• Their sole objective is to create and maintain a
successful organization so the shareholders prosper.

• In the stewardship, the manager is highly motivated

and committed to the business and to paying good
dividends to the shareholders, which helps providing
them with security for their investments.
• Managers are honorable and trust worthy.

• Steward’s behavior is pro-organizational and

collectivists.

• Focus of stewardship is on a structure that facilitate

and empowers rather than monitor and control.
CONCLUSION
Corporate governance is a relatively new area and its
development has been affected by a number of disciplines
including finance, economics, accounting, law and
management.
The main theory that has affected its development is the
agency theory. However, stakeholder theory is coming more
into play as companies become aware that they cannot
operate in isolation.
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YOU