A r t i c l e s
possible manner in the interest of shareholders. However, dueto this separation of ownership and control, shareholders whoare the true owners of a company, do not control it, the controlrather lies in the hands of the managers and directors who donot own the organization. Under this theory, the main problemin corporate governance is this separation that fuels divergenceof interests and the directors may divert from the profitmaximising aim and be rather interested in maximising theirself interest like increasing their perks and salaries, theirreputation (which may be at the cost of shareholder benefit),diversion of company assets for personal uses etc. Such adivergence of interest can be the root cause of bad corporategovernance.While the shareholder theory of corporate governance attachessupreme importance to the shareholders as owners of thecompany, the much wider view presented by the stakeholdertheory takes into account all the formal and informal, writtenand unwritten relations of a company viz., creditors, employees,suppliers, customers, other contractual parties, members of the society, institutions with various interests like those forenvironmental health hazards, governments and so on. Thistheory takes a broader notion of corporate governance andholds companies to be “socially responsible” organisations thatare typically to be managed in the interest of the public. Thus,the performance of a company is not only to be judged by theincrease in shareholder value but also from timely creditorpayments, enhancement of employee salaries and bettermentof job conditions, increase in market share, better relationswith suppliers, customers, the government (which wouldencompass the better compliance with rules and regulationspart) etc. Therefore, companies with better corporategovernance are those that have dedicated and long standingsuppliers, customers, creditors and employees, and those withgood compliance record and little or no litigation against.There are problems with both the theories as also with theprincipal-agent concept. In a company, the principal-agentproblem and the divergence of interests would not have arisenif it were possible to write ‘complete contracts’ at the veryinception of the company. A complete contract in this casewould have meant a contract specifying every contingencyand every single mandatory act for the agents or directors inevery possible situation. The problem is, it is not possible toforesee every contingency
, and that is whycontingencies are contingencies and not certainty. A completecontract could have ensured that there is no divergence of interests. Hence there would have been no need to worry aboutcorporate governance problems. We do worry becausecomplete contracts are not feasible and it is impossible topredict everything the future holds for us. The incompletenessprovides the scope of ‘residuals’ and the question arises as to‘how to efficiently allocate those residuals’. It is because of this that we need a mechanism that provides for efficientdecision making in situations that were not foreseen at theinception of the contract. Such efficient decision making wouldimply efficient use of discretion and accountability of directors.Thus good corporate governance is required to reduce thechances of ex-post opportunistic behaviour by directors andmanagers and divergence of their interest from the real ownersof a company so that investors do not shy away their investmentin companies due to non-reliance on directors. This wouldresult in a hold-up situation and adversely affect the economy.It is to check the occurrence of such situations that theshareholder theory of corporate governance has developed.As in the shareholder theory, even in the stakeholder theorythere are chances that all ‘investors’ (meaning all ‘stakeholders’here) shy away their investment because they do not get properreturns on their investment. To take an example, there may bea non-optimum investment of employees into the humancapital of the company, the suppliers may under-invest in theform of low quality raw-materials and customers may under-invest by buying less of the company products. Similarlycreditors may under-invest by unfavourable credit terms, whileunderinvestment from distributors may take the form of inefficient distribution network and so on. The basic idea of corporate governance is to ensure the most optimum investmentfrom all stakeholders and optimum allocation of all types of resources and that there is continuity and sustainability of efficient business relationship amongst all components of acompany that make firm specific investment.The right corporate governance strategy suitable for anenterprise can provide solutions to most of these problemsof divergence of interest, hold-up, inefficient allocation of financial and other resources, unproductive uses of resources,diversion of company’s assets for personal use etc.Meanwhile, before proceeding further into discussing whatwill be an ideal corporate governance mechanism, it isworthwhile to have a quick look at the various methods toalign the directors’ and managers’ interest with those of theshareholders:
To give more power to shareholders for overseeing andcontrolling management activity. This can take the formof certain legal protection in the form of minority rights,prohibitions of insider-dealing, increase of disclosurenorms etc.
To try and give incentives to managers for efficientmanagement and accountability in the form of attractiveperks, stock options, sweat equity etc.
To make laws stricter with respect to compliances andnorms to be followed (the kind of corporate governanceus professionals are more inclined to think of)
Corporate Governance – An Economic Perspective