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Assignment: Theories & Models of Corporate Governance.

Introduction: Contemporary corporate governance started in 1992 with the Cadbury report in the UK. Cadbury was the result of several high profile company collapses. In beginning it concerned primarily with protecting weak and widely dispersed shareholders against self-interested directors and managers. But now a day its purpose is to protect the rights of all stakeholders.

Corporate Governance: Corporate governance refers to the set of systems, principles and processes by which a company is governed. They provide the guidelines as to how the company can be directed or controlled such that it can fulfill its goals and objectives in a manner that adds to the value of the company and is also beneficial for all stakeholders in the long term. Stakeholders in this case would include everyone ranging from the board of directors, management, shareholders to customers, employees and society. The management of the company hence assumes the role of a trustee for all the others.

Theories of Corporate Governance

1. Agency theory: In the modern corporation, where share ownership is widely held, managerial actions depart from those required to maximize shareholder return. In agency theory terms, the owners are the principals and the managers are the agents. Agency loss

Is the extent to which returns to owners fall.

2. Stewardship Theory: The stewardship theory assumes that managers are basically trustworthy and attach significant value to their own personal reputation. It defines situation in which managers are stewards whose motives are aligned with the objectives of their principles. A stewards behavior will not depart from the interests of his/her organization. Control can be potentially counterproductive, because it undermines the pro-organization behavior of the steward by lowering his/her motivation.

3. Stakeholder Theory: The stakeholder theory is grounded in many normative, theoretical perspectives including ethics of care, the ethics of fiduciary relationships, social contract theory, theory of property rights, and so on. Stakeholder theory is often criticized, mainly because it is not applicable in practice by corporations.

4. Sociological Theory: The Sociological theory has focused mostly on board composition and wealth distribution. Under this theory, board composition, financial reporting, and disclosure and auditing are the utmost importance to realize the socio-economic objectives of corporations.

Difference between 4 theories of Corporate Governance


Agency theory: Trust:

In this it assumes that management is not trustworthy and we have to keep check and balance on it.

Self interest of Management: Shareholders interest can be compromised if manager maximize their self-interest at the expense of organizations profitability.

Loss: We assume that the agent may not put enough effort to achieve organizational objective as they may feel that why to put so much effort for someone and this may result in loss or agency loss. Agency loss means the extent to which returns to owners fall.

Control: Agency theory specifies mechanisms that reduce agency loss. Fair and Accurate Financial Disclosure Efficient and Independent Board of Directors Above two points work as a check on agent.

Motivation and Productivity level: This theory dont focus on motivation and productivity level but after some research it was revealed that so much checks and controls lower the motivation level and it reduce productivity level.

Stakeholder theory Trust: The stewardship theory assumes that managers are basically trustworthy and are viewed as loyal to the company.

Self interest of Management: Unlike agency theory, stewardship theory assumes that managers are stewards whose behaviors are aligned with the objectives of their principals.

Loss: In this it assumes that management are interested in achieving high performance and try to avoid loss as it aligned their behaviors with the objectives of the principle.

Control: In this theory it is assumes that control can be potentially counterproductive, because it undermines the pro-organization behavior of the steward by lowering his/her motivation

Motivation and Productivity level:

This theory focuses more on motivation and productivity level. In this theory it is assumes that if you show trust on management it will enhance the motivation level of management and management will work more hard and to increase productivity level of organization

Stakeholder Theory: Focus: Its only emphasis on stakeholders rights and corporate responsibility towards its stakeholders and nothing else and due to its limited focus it was rejected and cannot be used in practice. Socio-economic objectives: It only focuses on social objectives of corporation.

Sociological Theory: Focus: It focuses equally on board composition, wealth distribution and corporate responsibility towards society.

Balance board: This theory focuses more on board composition - which means board should be mix of its external and internal members.

Socio-economic objectives:

This theory focuses on both social and economic objective of the organization.

4 Models of Corporate Governance


1. The Anglo-American Model: The so-called "Anglo-American model" of corporate governance emphasizes the interests of shareholders. It relies on a single-tiered Board of Directors that is normally dominated by nonexecutive directors elected by shareholders. Because of this, it is also known as "the unitary system")

2. The German Model: Some continental European countries, including Germany and the Netherlands, require a twotiered Board of Directors as a means of improving corporate governance. In the two-tiered board, the Executive Board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and labor unions & employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions.

3. The Japanese Model: The Japanese model is characterized by a high level of stock ownership by affiliated banks and companies; a banking system characterized by strong, long-term links between bank and corporation.

4. Indian Corporate Governance Model: India's SEBI (Securities and Exchange Board of India) Committee on Corporate Governance defines corporate governance as the "acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company. It has been suggested that the Indian approach is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution, but this conceptualization of corporate objectives is also prevalent in Anglo-American and most other jurisdictions.

Difference between 4 models of Corporate Governance:

The Anglo-American Model: Only share holders have authority to elect Board of Directors of the company. Managers are appointed and supervise by board, so it can be said that board have influence over managers.

The German Model: It is the simplest model. Shareholders and employees & labor union have 50%-50% authority to appoint the Board.

The Japanese Model: Who ever so investor have a right in management

President is not independent as president has to consult from Executive Management (Primarily Board of Directors) and president decisions can be ratifies by Supervisory Board (Including President).

Indian Corporate Governance Model It is the most complex model of corporate governance. In this corporate culture is healthy. It also represent that India have weak legal system as the strong the legal system, the simple the governance model and vice versa (According to Prof. Muzafar).