BACC 6: CORPORATE GOVERNANCE AND CSR

Professor: Josie D. Fuentes, DM

LESSON 2
CONCEPTS OF CORPORATE GOVERNANCE, ETHICS THEORY
AND BEYOND

I. LEARNING OBJECTIVES:

At the end of the lesson, students will be able to:

1. explain concepts, theory and practices of corporate governance
2. realize the corporate governance mechanism
3. discuss the landmarks in emergence of corporate governance
4. define ethics and explain the importance of good ethics for business people and
business organizations
5. explain the difference between shareholder and stakeholder models of ethical
corporate governance

II. CONTENT:

Topic 1: Concepts of Corporate Governance

Introduction
The concept of governance defined in the 1999 OECD Principles of Corporate
Governance as: the system by which business corporations are directed and controlled.’
The ‘holy trinity’ of good corporate governance has long been seen as shareholder rights,
transparency and board accountability. While corporate governance is overtly concerned
with board structure, executive compensation and shareholder reporting, the underlying
assumption is that it is the board that is responsible for managing and controlling the
business.

The principles, structure and systems of corporate governance should be applied

in a wide range of organizations – not just publicly listed joint stock companies, but also
throughout the banking sector, in state enterprises, in co-operatives, in the ever-growing
and increasingly important NGO sector, and in public services such as health and
education boards.

Theory and Practices of Corporate Governance

In order to appreciate how theories have tried to make sense of corporate

governance issues, reference has been made to four widely discussed theories which are
commonly used to understand how corporations are governed and how the system of
corporate governance can be improved. The development of corporate governance is
bound intimately with the economic development of industrial capitalism: different
governance structures evolved with different corporate forms designed to pursue new
economic opportunities or resolve new economic problems.

Shareholders Theory vs. Stakeholders Theory

Shareholder theory or agency theory asserts that shareholders advance capital

to a company's managers, who are supposed to spend corporate funds only in ways that
have been authorized by the shareholders.

The agency problem was effectively identified by Adam Smith when he argued that
company directors were not likely to be as careful with other people’s money as with their
own. Agency theory offers shareholders a pre-eminent position in the firm legitimized not
by the idea that they are the firm’s owners, but instead its residual risk takers.

Since, the basis of agency theory is the self-interested utility-maximizing motivation

of individual actors, it is assumed that the relationship between shareholders (principals)
and managers (agents) will be problematic. Internal and external governance
mechanisms help to bring the interests of managers in line with those of shareholders,
including:

1. An effectively structured board;

2. Compensation contracts that encourage a shareholder orientation;
3. Concentrated ownership holdings that lead to active monitoring of executives;
4. The market for corporate control that is an external mechanism activated when
Internal mechanisms for controlling managerial opportunism or failure have not
worked.

On the other hand, stakeholder theory asserts that managers have a duty to both the
corporation's shareholders and "individuals and constituencies that contribute, either
voluntarily or involuntarily, to a company's wealth-creating capacity and activities, and
who are therefore its potential beneficiaries and/or risk bearers."

The firm is a system of stakeholders operating within the larger system of the host society
that provides the necessary legal and market infrastructure for the firm’s activities. The
purpose of the firm is to create wealth or value for its stakeholders by converting their
stakes into goods and services.

Stewardship Theory

Steward is a person who manages other’s property or financial affairs and is

entrusted with the responsibility of proper utilization and development of organization’s
resources. According to stewardship theory, the behavior of the steward is collective,
because the steward seeks to attain the objectives of the organization. Given the potential
multiplicity of shareholders’ objectives, a steward’s behavior can be considered
organizationally centered. Stewards in loosely coupled, heterogeneous organizations
with competing stakeholders and competing shareholders objectives are motivated to
make decisions that they perceive are in the best interests of the group.

Property Rights Theory

In the new institutional economics, property rights are viewed simply as control rights over
physical and human assets. More specifically, they are institutions (or sets of rules and
enforcement attributes) that help people form reasonable expectations about control over
assets. These institutions consist of laws, administrative arrangements, and social norms
relating to the allocation and enforcement of control rights over assets.

Property rights shape corporate governance in two fundamental and related ways. First,
they determine what types of firms will emerge in a given environment. Like all
organizations, firms arise in response to the incentives and transaction costs generated
by the existing institutional framework. Second, the specific governance mechanisms
available to firms are constrained by existing property rights institutions, which specify the
legitimate forms of control in any given community.
Topic 2: Ethics Theory and Beyond

Think of a person who did something morally wrong, at least to your way of thinking. What
was it? Explain to a friend of yours—or a classmate—why you think it was wrong. Does
your friend agree? Why or why not? What is the basic principle that forms the basis for
your judgment that it was wrong?
Most of those who write about ethics do not make a clear distinction between ethics and
morality. The question of what is “right” or “morally correct” or “ethically correct” or “morally
desirable” in any situation is variously phrased, but all of the words and phrases are after
the same thing: what act is “better” in a moral or ethical sense than some other act?

What is Ethics? Why?

Ethics shows a corporation how to behave properly in their all business and operations.
Ethics is the set of rules prescribing what is good or evil or what is right or wrong for
people. In other words, ethics is the values that form the basis of human relations, and
the quality and essence of being morally good or evil, right or wrong. Business Ethics
means honesty, confidence, respect and fair acting in all circumstances. Ethics can also
be defined as the overall fundamental principles and practices for improving the level of
wellbeing of humanity.

Ethics are codes of values and principles that govern the action of a person, or a group
of people regarding what is right versus what is wrong (Levine, 2011; Sexty, 2011).

Therefore, ethics set standards as to what is good or bad in organizational conduct and
decision making (Sexty, 2011). It deals with internal values that are a part of corporate
culture and shapes decisions concerning social responsibility with respect to the external
environment. The terms ethics and values are not interchangeable (Mitchell, 2001).
Whereas ethics is concerned with how a moral person should behave; values are the
inner judgments that determine how a person actually behaves. Values concern ethics
when they pertain to beliefs about what is right and wrong.

The advantages of ethical behavior in business include the following (Mitchell, 2001):

1. Build customer loyalty

2. Retain good employees
3. Positive work environment
4. Avoid legal problems

Identifying Ethical Issues and Dilemmas

Ethical issues are the difficult social questions that involve some level of controversy over
what is the right thing to do. Environmental protection is an example of a commonly
discussed ethical issue, because there can be tradeoffs between environmental and
economic factors. Ethical dilemmas are situations in which it is difficult for an individual to
make decisions either because the right course of action is unclear or carries some
potential negative consequences for the person or people involved.

Issues of Honesty and Integrity

Conflicts of interest occur when individuals must choose between taking actions that
promote their personal interests over the interests of others or taking actions that don’t.
A conflict can exist, for example, when an employee’s own interests interfere with, or have
the potential to interfere with, the best interests of the company’s stakeholders
(management, customers, and owners).

A Conflict of loyalty means a particular type of conflict of interest, in which a

trustee's loyalty or duty to another person or organization could prevent the trustee
from making a decision only in the best interests of the charity.

The Three E-Equation

Many business managers have added a variable to the manager’s decision-making

equation. For them, the equation might be called the Three-E Equation:

Efficiency + Effectiveness + Ethics = Profits + Long-Term Stability

Some managers, however, continue to accept the belief that the stakeholders’ hunger for
stronger and stronger bottom lines is incompatible with the addition of ethics as illustrated
in the Three-E Equation. As a result, businesses are often left with cognitive dissonance;
that is, they hold two opposing views simultaneously. Their beliefs maintain that certain
principles are absolutes and contribute to the well-being of individuals and society.
However, the business setting often uses an action system that honors higher profits
above the well-being of individuals or moral values.

Therefore, it is imperative for all managers generally—to have a well-established

framework and a belief system to guide the decision-making process. Without such a
system, managers often will make decisions erratically, decisions that are dictated by the
“squeaky wheel” or a blind desire to maximize profits at any cost.

III.TEACHING-LEARNING ACTIVITIES (TLA):

TLA 1:

1. “If management is about running business, governance is about seeing that it is run
properly”. In the light of this statement, discuss the idea of corporate governance.
2. Analyze the role of government in corporate governance.
3. What justification does Stakeholder theory use for considering stakeholders?
4. Why does a company have to be ethical?
TLA 2:

1. Think of a person who did something morally wrong, at least to your way of
thinking. What was it? Explain to a friend of yours—or a classmate—why you think
it was wrong. Does your friend agree? Why or why not? What is the basic principle
that forms the basis for your judgment that it was wrong?

2. Think of an action by a business organization (sole proprietor, partnership, or

corporation) that was legal but still strikes you as wrong. What was it? Why do you
think it was wrong?

IV. REFERENCES:

A C Fernando, Corporate Governance: Principles, Policies and Practices, Pearson

Christine A., Corporate Governance, Oxford University Press, 2004.

Geeta Rani, R K Mishra, Corporate Governance: Theory and Practice, Excel Books
Parthasarthy, Corporate Governance: Principles, Mechanisms and Practices, Biztantra

Mitchell, J. A. (2001). The ethical advantage: Why ethical leadership is good business

Sexty, R. (2011). Canadian business and society: Ethics and responsibilities (2nd Ed.).
Toronto. McGraw-Hill Ryerson.

en.wikipedia.org/wiki/Corporate_governance
www.corpgov.net/
www.oecd.org/corporate
www.nfcgindia.org/