THEORIES OF CORPORATE

GOVERNANCE
Session 2
Prof. Supriti Mishra
 CORPORATE GOVERNANCE: A CONCEPTUAL ANALYSIS

• Mechanism of Corporate Governance

• Internal Mechanism
• Internal mechanism maintains the internal order in the company and helps in achieving
its objectives
• Includes smooth operations of the company and performance measurement and
management.
• External Mechanism
• The external mechanism, also termed as an external control mechanism, is in the hands
of those outside the corporation, which serves the objectives of entities like the
government, trade unions, regulators, and last but not the least, financial institutions.

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Investor’s Dilemma
Good
Good Company Governance

Bad Company
Poor
Governance

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Information Asymmetry
-The Used Car Market
What is the Value of
this Used Car?

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Prof. Supriti Mishra, IMIB
Does Governance Add Value?
• Why should well governed companies add value?
• Lower information asymmetry
• Lower cost of capital
• Easy to raise money from equity market
• High brand value
• Low employee turnover

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 Corporate Governance Codes
• Good CG codes stress on
• Transparency in financial & non-financial disclosures
• Adoption of internationally compatible accounting standards
• Due board processes and compliance with legal and
regulatory requirements
• Accountability to various stakeholders,
• Majority of outside directors to have no formal ties with the
management
• Regular formal evaluation of directors, etc.
• Various codes – Sarbanes-Oxley Act in USA, Cadbury
committee code in UK, SEBI guidelines in India

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RULES & PRINCIPLES OF CORPORATE
GOVERNANCE
• The rules and principles of corporate governance steer and guide
the relationship between the management and shareholders.
• Greater legal regulation of corporate governance translates to
greater disclosure in the interests of shareholders and lesser extent
of secrecy in the functioning of the corporation.
• Emergence of independent corporations – led to a need to evaluate
the structure of corporations and the governance of these
institutions.

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 THEORIES OF CORPORATE GOVERNANCE

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 THEORIES OF CORPORATE GOVERNANCE
• Agency Theory
• Presumes the existence of the principal-agent relationship between the
shareholders and directors of the corporation and seeks to provide the
justification for corporate governance.
• The shareholders employ the managers to run the corporation in the
best interests of the shareholders.
• Managers may be motivated by their own interests. This may lead to the
mismanagement of the corporation.
• Two processes can be envisaged to solve the problem
• Employment of Resources
• Shareholders employ resources i.e. the managers and directors
to look after the business on a day-to-day basis. Therefore,
there has to be certain faith on the abilities of directors and
managers
• Personal Advantage Appropriation by Managers and Directors

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 THEORIES OF CORPORATE GOVERNANCE
• Core Principles of Agency Theory

Assumptions
• Actors in the model are
rational, individualistic and
opportunistic
• Actors always try to
maximize own benefits and
personal utility

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 THEORIES OF CORPORATE GOVERNANCE
Stewardship Theory
• Characterises the directors as the
stewards of the business and Shareholders
corporation
• Alignment of Goals of the managers
and shareholders
Who accept a fiduciary
• Exercise of Choice -The manager does To protect their interests duty to be stewards of
not depart from the choices and nominate and elect those interests
objectives of the company. This
minimises his self-serving behaviour
• Control Mechanism - control is
counterproductive in this model as
stewardship thrives on proactive
behaviour of managers Directors

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THEORIES OF CORPORATE
GOVERNANCE
• Stewardship Theory
• Classical idea of CG
• Directors’ legal duty is to their shareholder and not to themselves or to other
interest groups
• Directors must recognise the need of various stakeholders but under the law
their first responsibility is to shareholders
• Reflects the legal model
• Directors report about their stewardship to shareholders subject to
classification of the statements by an independent auditor

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THEORIES OF CORPORATE GOVERNANCE
• Stakeholder Theory
• The stakeholder theory, refers to the
company and the directors taking into
consideration the interests of all involved
in the process of management.
• Key Elements
• Prioritisation of interests
• Strategic decision-making
• Efficiency
• Key challenges involved
• Determination of the stakeholders
who are genuine is not always
possible as well as the fact that the
practical applicability of the theory is
liable for criticism.

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THEORIES OF CORPORATE GOVERNANCE
• Who is a Stakeholder: Typology
• Primary stakeholders
– Employees, customers, investors, suppliers, government, and
community with whom the corporation may have a formal,
official, or contractual relationship
– Internal and External stakeholders
• Internal: employees and investors
• External: customers, communities, suppliers, government, and natural
environment
• Secondary stakeholders
– Media and special interest groups towards whom a firm does not
have any contractual obligation

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To whom are we responsible?:
Complexity of Stakeholder
Expectations

Govt. NGOs
Community Labour Union

Trust Me Tell Me Show Me Involve Me

Activists Investors
Peers
Media Groups
 To whom are we responsible?

Power

Urgency Salience

Legitimacy

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THEORIES OF CORPORATE GOVERNANCE
• Resource Dependency Theory
• Dependency of the corporation on the access to resources provided by the board of directors.
• Directors are boundary-spanning nodes of networks able to connect the business to its strategic
environment
• Board members can provide access to new customers, external capital, power and information
about innovation and R&D
• As firms operate in a complex and dynamic environment, access and control over resources to face
the challenges from the external environment is paramount to achieve success.
• Board members who serve as directors in multiple firms can prove useful to firms
• Firms can leverage the knowledge and experience of these directors to get information about new
trends in the industry and how other firms cope up with such complex environments (Davis, 1991).
• Board members who serve in the boards of banks and other financial institutions can provide
financial capital in times of need

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 THEORIES OF CORPORATE GOVERNANCE
• Categories of Directors in Resource Dependency Theory

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THEORIES OF CORPORATE GOVERNANCE
• Social Network Theory
• Directors are viewed as boundary-spanning nodes of networks to be able to connect
the business to its strategic environment
• Those involved in corporate governance processes are often linked through
networks
• Individuals at the nodes may have things in common including social standing, class,
income, education, institutional or corporate link
• Individuals in the networks such as the chairman or the CEO, may be pivotal nodes in
a number of networks, have communication leverage
• Such social networks can enhance or adversely interfere with the independent and
objective governance activities

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 THEORIES OF CORPORATE GOVERNANCE
• Transaction Cost Theory
• The transaction cost theory forms the basis of corporate governance as it focuses on finding
the most optimal manner of employing the resources in a corporation in the best interests of
the shareholders
• Large corporate groups can overcome the disadvantage of scale by the choice of governance
structures
• Make vs buy decision
• Compelling reasons for the transaction costs
• Explicit Costs
• Implicit Costs
• Costs for negotiations
• Costs for information
• Transaction cost economics focuses on the cost of enforcement or check and balance
mechanisms such as internal and external audit controls, information disclosure,
independent outside directors, separation of board chairmanship from CEO, risk
analysis, audit, nomination and remuneration committees
• Such enforcement costs should be incurred up to the point at which increase in costs
equals the reduction of the potential loss from non-compliance
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 THEORIES OF CORPORATE GOVERNANCE
• Political Theory
• The ‘active investors seek to change corporate policy by developing
voting support from dispersed shareholders, rather than by simply
purchasing voting power or control.
• The corporate governance systems here may be characterised by 2 main
groups
• Market-oriented System
• Because of the dispersed shareholding, the extent of control by any
shareholder is relatively lower
• Political intervention aims at achieving economic efficiency in such a
scenario
• Bank-oriented System
• Centralised shareholding pattern safeguarding the interests of shareholders

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THEORIES OF CORPORATE GOVERNANCE
• Political Theory
• The effectiveness of the approach depends on various factors
• Degree of social cohesion
• Connected directors support each other and serve self-interests instead
of shareholders’ interests
• Degree of sophistication in the economy
• Extent of public faith in government institutions
• Efficacy of the actors

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 THEORIES OF CORPORATE GOVERNANCE
• Ethical Theories
• The ethical theories are a relatively new basis for the practice of corporate
governance and are based on
• Business ethics
• Rights and wrongs in business
• Virtue ethics
• Moral excellence, goodness, chastity and good character
• Feminist ethics
• Empathy, healthy social relationship, loving care for each other and the
avoidance of harm
• Discourse ethics
• Type of arguments that tries to establish ethical truths by investigating the
presuppositions of discourse
• Postmodern ethics
• Emphasis on long term goals of business along with focus on values and ethics
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 THANK YOU

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