Theories of Corporate Governance

Abstract

In this chapter, important ideas in corporate governance are briefly reviewed for the reader. Researchers and students can simply build up and develop their theoretical framework from this thorough base, depending on their particular research aims.

Introduction

A company is a formal organization or collection of people who work together to conduct business and make money. The company is constantly in need of investments and capital, thus the owner reduces its stake in order to raise money and enlist the public. A CEO of the company is typically appointed by a flourishing company to oversee its operations.

The management wants to earn a fixed income from the business, while the owner's primary goal is to create a profit. The necessity for corporate governance comes as a result of the growing disconnect between the owner's and manager's goals and vision. When the Company begins to prosper, the necessity for corporate governance becomes apparent. Corporate governance establishes how businesses are managed and directed. It is founded on the FAT (Fairness, Accountability, and Transparency) principle. It describes the steps taken by the organisation to enhance its interactions and relationships with its stakeholders, including its shareholders, board of directors, investors, members of the general public, government agencies, business partners, and employees.

To balance the interests of all the interested stakeholders, compliance with the set of rules, processes, and operational structure must be observed.

Agency Theory

The relationship between principals (like company shareholders) and agents (like company directors) is defined by agency theory. This notion states that the company's owners employ the agents to carry out tasks. The directors or managers, who are representatives of shareholders, are given the task of managing the company by the principles. The shareholders anticipate that the agents will act and choose in the principal's best interests. On the contrary, it is not required that the agent decide in the principals' best interests. The agent might give in to self-interest and opportunistic behaviour and fail to live up to the principal's expectations. Separation of ownership and control is the main component of agency theory. According to the principle, individuals or workers should be held accountable for their duties and commitments. Agents' priorities can be adjusted through rewards and penalties.

According to agency theory, a principal hires an agent due to their knowledge and cost. The principle may determine that their company lacks the resources or the necessary experience to create a good or service and that it would be more expensive to hire or acquire such competence internally than to contract for it. Both the principal and the agent have agreed to the contract's terms, including its requirements for monitoring and performance reporting, inputs, processes, outcomes, quality and satisfaction metrics, and how the agent will be paid for carrying out the principal's work. They also agree to the sanctions that will be applied if the principal discovers that the agent is prioritising his or her own interests over the principal's goals.

Steward theory

With an emphasis on collective, pro-organizational, contractual behaviour where a larger importance is placed on goal convergence than on agent self-interest, stewardship theory investigates relationships and behaviours that are frequently dismissed in organisational economic theories. Stewardship theory bases its premises on the idea that long-term contractual relationships emerge based on reputation, trust, shared goals, and involvement, with alignment emerging as a byproduct of relational reciprocity.

Stewardship theory is an appropriate model for the relationship between the government and nonprofits that provide social services because nonprofits may well be more aligned with each other.

Stakeholder theory

The accountability of management to a wide range of stakeholders was incorporated into stakeholder theory. The idea focuses on managerial decision-making and assumes that all stakeholder interests have intrinsic worth and are not in competition with one another.

There are numerous stakeholder theories, not just one. It might be considered a genre of theories. Stakeholder theory places ethics at the centre of business, if you were to ask me to name one distinguishing feature that sets it apart from other approaches. 

You might find it a little odd to connect ethics and business. You could picture universal truths, angels and demons, or anything like, when you think about ethics. Of course, that's a component of it. Stakeholder theory, on the other hand, lends ethics a far more practical perspective. It claims that ethics is something we all do on a daily basis to solve issues and improve conditions for everyone.

This realistic perspective would seem to place ethics at the very core of business. In business, we strive to comprehend the kinds of goods and services that consumers should purchase in order to improve their lives. We make an effort to give people fulfilling jobs and, of course, pay. To obtain the products and resources a firm need, it is important to have solid and secure partnerships with suppliers. It involves comprehending how businesses can integrate into and benefit from the communities in which they operate. Of course, it also involves comprehending how businesses can compensate investors for the money they contributed and the risk they assumed in doing so. As a result, if we consider ethics to be something that facilitates the functioning of our daily lives, it does indeed

Resource Dependency Theory

The availability of resources improves organisational performance, a firm's ability to compete, and its ability to survive. Directors can be divided into four groups: community influencers, business experts, support specialists, and insiders.

Although the dependence of companies on outside resources had long been recognised, it wasn't until the 1970s that the notion regarding the risks of this dependence gained popularity.

The book "The External Control of Organizations: A Resource Dependence Perspective" was written by Jeffrey Pfeffer and Gerald R. Salancik. It covered the origins of power and dependence as well as how organisations might utilise this power to control other organisations that are dependent on them.

Managers and leaders are constantly looking for methods to better their own company as well as their ties with other firms.

Social Contract Theory

Although many people challenge (quite rightly) its historicity, the concept of social contract is highly well known and popular in social research, and particularly in political science. Many eminent political scientists still today wish to use the social contract theory as the foundation for their views.

The social contract is a document that stipulates certain requirements. Some persons assert that they are not required by law to follow orders from higher authorities, or that the authority is not required by law to perform certain tasks. Social contract theory may be employed as a tool in that circumstance.

Based on the agreement of all parties present at the moment the terms and conditions of the contract were finalised, we can conclude that the social contract is a legal document. A society or political organisation that was founded by this legal contract is likewise a legal political organisation.

As a result, one legal document ends up having the capacity to influence numerous other legal issues. The significance or veracity of contracts as the source of the basis of political society may be questioned by some. This query or rebuttal is quite ancient.

Benefits of Corporate Governance

A good firm can become a great one with sound corporate governance. In every business, the best corporate governance practises have propelled the leaders to the top of their respective fields.

• Lessening of fines and penalties: Because corporate governance practises take care of the legal compliance issue, businesses can avoid paying out a fortune in unwarranted fines and compliance fees and instead use those funds to further their business goals.
• Better management: Since the entity has a structure in place for how it functions on a daily basis, controlling the operations and hitting goals is much simpler. In accordance with sound corporate governance practises that promote teamwork, unanimity, efficiency, and a desire for achievement, the workplace environment also takes care of itself.
• Lesser conflicts and frauds: The standards that are ingrained in the workplace urge employees to act morally in any scenario they find themselves in, removing the likelihood of fraud and employee conflict.

Conclusion

Theories of corporate governance have their origins in agency theory, which has consequences for the idea of moral hazard. Stewardship theory and stakeholder theory have since developed, and political theory, resource dependence theory, and transaction cost theory have also advanced. Later, the theories of efficient markets, informational asymmetry, and ethics were added to these theories. Based on the causes and effects of several factors, such as the composition of the board of directors and audit committee, the independence of directors, the function of senior management, and their interpersonal relationships outside of the legal and regulatory framework, these theories are outlined.