UGANDA MANAGEMENT INSTITUTE (UMI)

COURSE : PhD (Management and Administration)

MODULE : Corporate Governance and Innovation

LECTURER : Dr. Stella Kyohairwe

STUDENT : Nelson Woira Kyagera

PhD/WKD/1/005

DATE : June 2013

Abstract

In view of the malfunctioning state of many corporations today, some pundits disagree with the
proposition that good corporate governance practices instill in corporations the essential vision,
processes and structures to make decisions that ensure growth and sustainability of organizations
This school of thought considers the above proposition to be a mere assumption. In light of this
debate, this paper sets out to explore the theoretical conceptions of corporate governance and the
associated practice challenges based on the Ugandan context. This exploration finds that while it
is true that corporate governance practice is heavily influenced by the corporate governance
theory adopted by a particular corporation, it is also true that the associated challenges also stem
from the very nature of these theories. It also finds that good corporate governance practices
indeed do support corporations in their quest for growth and sustainability. The paper
recommends that, among other solutions, adoption of a combination of corporate governance
theories that simultaneously ensure streamlining of organizational structures and responsibilities,
promotion of social relationships, and also do emphasize observance of rules, legislation and
ethical values will be a panacea to the corporate governance challenges in practice.
Key Words: board of directors, corporate governance, corporations, corporate growth, corporate
sustainability, senior management, shareholders, stakeholders.

INTRODUCTION

Corporate governance deals with the complex set of relations between the corporation and its
board of directors, management, shareholders and other stakeholders. According to Abdullah &
Valentine (2009), corporate governance can be defined as a set of processes and structures for
controlling and directing an organization. It constitutes a set of rules, which governs the
relationships between management, shareholders and stakeholders.
This subject has gained academic and public interest and as observed by Letza (2002) it has been
a much discussed topic in economics, management, business ethics, company law and other
disciplines in recent years. Letza further contends that wider public concern over fraud and
corporate collapse, executive overpay, abuses of management power and corporate social
irresponsibility in the last two decades has resulted in increased interest in this subject as
evidenced by a series of formal reports and proposals put forward in many developed as well as
developing countries.
There are several factors that account for this renewed interest in the study and practice of
corporate governance some of which are; the rise of globalization, rapid technological change
especially in the area of information and communications technologies (ICTs) and mass media,
which in turn is compressing space and time and deconstructing geographic and political
barriers. Other contributory factors to the renewed interest in corporate governance are; the

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waves of business mergers which have accelerated levels of corporate concentration at both the
national and international levels; radically altered labour market structures and employment
relationships within advanced capitalist democracies; the growth of poverty, income polarization,
and social exclusion; and significant fiscal stresses on the state which have compelled
governments to put their financial houses in order.

CORPORATE GOVERNANCE PLAYERS

While there is a multiplicity of players in corporate governance, the key ones are; shareholders,
board of directors, and senior management. Each of these categories plays a key leadership role
in the governance of a corporation (Pangas, 2007).

Shareholders are the owners of the corporation and they therefore have a direct financial interest
in its performance, growth and sustainability. In this respect, the senior management and the
board of directors ultimately work for the benefit of the corporation’s shareholders. Their main
role is to regularly attend both general and annual meetings to among other reasons ensure that
the directors do not go beyond their powers. Shareholders are generally not empowered to
initiate significant corporate plans and actions on behalf of the corporation, although in some
special circumstances such plans and actions initiated by senior management may require
shareholder approval beyond the board of directors.

A board of directors is appointed or elected to act on behalf of the shareholders. It is tasked with
the ultimate responsibility for the oversight of the corporation’s business and affairs. One of the
most important oversight responsibilities of the board of directors is to monitor the senior
management on behalf of the shareholders and overseeing the conduct of the corporation’s
business to evaluate whether it is being properly run by senior management. Specific functions
of the board of directors include; selecting, determining the compensation of and replacing senior
management to the extent appropriate, reviewing and approving major corporate plans and
actions proposed by senior management. Ultimately the board of directors is responsible for
identifying and managing risks taken by the corporation, establishing internal controls to ensure
accurate financial reporting and providing channels for reports of potential misconduct.

Senior management of a corporation is responsible for running the day-to-day business

operations and informing the board of directors of the status of such operations. Management is

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also charged with maintaining an efficient organizational structure, development and
implementation of strategic plans, and operating within annual plans and budgets.

Apart from the above mentioned key players in corporate governance there are other players who
are categorized largely as the other stakeholders that include; government, suppliers,
competitors, customers or clients, and communities among others. The importance of these other
players is reflected in the social entity model which presents the corporation as a social
institution based on the grounds of fundamental value and moral order of the community. In this
regard the corporation has a collective, rather than individual identity and corporate executives
are representatives and guardians of all corporate stakeholders’ interests. This model prefers to
resolve disputes and conflicts of interest and overcome market failures and transaction costs by
nationalizing corporations or by using legal intervention within a public law framework and
improving the system of checks and balances (Letza, 2002).

THEORETICAL CONCEPTIONS OF CORPORATE GOVERNANCE

Many theories and models of corporate governance have been and continue to be postulated but
Abdullah & Valentine (2009), have proposed a classification into two broad categories, namely;
the fundamental theories of corporate governance, and the ethics theories closely associated with
corporate governance. According to this classification, the fundamental theories include; agency
theory, stewardship theory, stakeholder theory, resource dependency theory, transaction costs
theory, and political theory. The ethics theories category includes; business ethics theory, virtue
ethics theory, feminist ethics theory, discourse ethics theory and the postmodern ethics theory.
Agency theory is concerned with the relationship between the principals, such as shareholders,
and the agents such as the company directors and managers. This theory has its roots in
economic theory and it was exposited by Alchian and Demsetz (1972) and further developed by
Jensen and Meckling (1976). In this theory, shareholders who are the owners or principals of the
company, hire managers or agents to perform work. The shareholders expect the agents to act
and make decisions in the principals’ interest. On the contrary, the agent may not necessarily
make decisions in the best interests of the principals and may succumb to self-interest,
opportunistic behavior and falling short of congruence between the aspirations of the principal
and the agent’s pursuits. This may be manifest in three ways; information asymmetry where the

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agent withholds vital information from the principals thus causing loss to the owners, moral
hazard - where the agent may use the withheld information expressly for self interest to the
detriment of the shareholders, and adverse selection which is a situation in which agents
misrepresent the skills or abilities they bring to an enterprise resulting in non maximization of
the principal's wealth is not maximized. It is argued that argues agency theory looks at an
employee or people as an economic being, which suppresses an individual’s own aspirations
(Argyris, 1973). This may be the root cause of the tendency to opportunistic behaviour on part of
the agent which unfortunate behaviour does not serve the company and its principals well in
terms of profitability and sustainability.

The stewardship theory has its roots in psychology and sociology and Tricker (2009) posits that
it reflects the classical ideas of corporate governance in which agents can and do act responsibly
with independence and integrity. Davis, Schoorman & Donaldson (1997) aver that in this theory
a steward protects and maximizes shareholders’ wealth through firm performance, because by so
doing, the steward’s utility functions are maximized. The stewardship theory stresses integration
of top management’s goals as part of the organization and not the self interest perspective as in
the case of the agency theory. The stewards, who are the company executives and managers
work for, protect, and make profits for the shareholders and in so doing the stewards themselves
also thrive and prosper. Stewardship theory recognizes the importance of structures that
empower the stewards and offers more autonomy to them built on trust in order to maximize the
shareholders’ returns, in this way the stewards are satisfied and motivated when organizational
success is attained. It is suggested by Davis, etal (1997), that indeed this can minimize the costs
aimed at monitoring and controlling the agents’ behaviours. It is further advanced that in order to
protect their reputations as decision makers in organizations, executives and directors are
inclined to operate the firm to maximize financial performance as well as shareholders’ profits.
In this sense, it is believed that the firm’s performance can directly impact perceptions of the
executives’ individual performance as they are also managing their careers in order to be seen as
effective stewards of their organizations. Accordingly stewardship theory suggests unifying the
role of the CEO and the Chairman so as to reduce agency costs and to have greater role as
stewards in the organization. Letza (2002) observes that based on a traditional legal view of the
corporation as a legal entity in which directors have a fiduciary duty to the shareholders, the
stewardship theory argues that managers are actually behaving just like stewards to serve the

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shareholders’ interests and diligently work to attain a high level of corporate profit and
shareholder returns. Managers have a wide range of motives beyond a simple self-interest, such
as achievement, recognition and responsibility needs, the intrinsic satisfaction and pleasure of
successful performance, respect for authority, social status, and work ethics. Thus, the separation
of ownership from control does not inherently lead to a goal and interest conflict between
shareholders and managers. The separation actually promotes the development of managerial
profession, which is certainly beneficial for corporate performance and shareholder wealth. In
this regard, empowering managers to exercise unencumbered authority and responsibility is
necessary for the maximization of corporate profits and shareholders’ value.

Abdullah & Valentine (2009) contend that the stakeholder theory was embedded in the
management discipline in the 1970’s and gradually developed by Freeman (1984) incorporating
corporate accountability to a broad range of stakeholders. They argue that stakeholder theory is
derived from a combination of the sociological and organizational disciplines and that indeed
stakeholder theory is less of a formal unified theory and more of a broad research tradition,
incorporating philosophy, ethics, political theory, economics, law and organizational science.
Stakeholder theory can be defined as “any group or individual who can affect or is affected by
the achievement of the organization’s objectives”. According to Letza (2002) the stakeholder
theory consists of several perspectives, key of which are; the social entity, the pluralistic and the
trusteeship models. The social entity conception regards the corporation not as a private
association united by individual property rights, but as a public association constituted through
political and legal processes and as such it is a social entity for pursuing collective goals with
public obligations. The corporation has a collective, rather than individual identity and
executives are representatives and guardians of all corporate stakeholders’ interests. The
pluralistic perspective supports the idea of multiple interests of stakeholders, rather than
shareholder interest alone. It argues that the corporation should serve and accommodate wider
stakeholder interests in order to make the corporation more efficient and legitimate. The
trusteeship model adopts a realistic and descriptive perspective in viewing the current governing
situation of a publicly held corporation which is a social institution with a corporate personality

The resource dependency theory on the other hand takes a strategic view of corporate
governance (Tricker, 2009).

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In contrast to the stakeholder theory’s focus on relationships with many groups for individual
benefits, the resource dependency theory concentrates on the role of board directors in providing
access to resources needed by the firm. Johnson et al, (1996) concur that resource dependency
theorists provide focus on the appointment of representatives of independent organizations as a
means for gaining access in resources critical to the firm’s success. For example, outside
directors who are partners to a law firm provide legal advice, either in board meetings or in
private communication with the firm executives that may otherwise be more costly for the firm
to secure. In this regard, Abdullah & Valentine (2009) argue that the provision of resources
enhances organizational functioning, performance and survival. Accordingly, directors can be
classified into four categories of; insiders, business experts, support specialists and community
influentials. First, the insiders are current and former executives of the firm and they provide
expertise in specific areas such as finance and law on the firm itself as well as general strategy
and direction. Second, the business experts are current, former senior executives and directors of
other large for-profit firms and they provide expertise on business strategy, decision making and
problem solving. Third, the support specialists are the lawyers, bankers, insurance company
representatives and public relations experts and these specialists provide support in their
individual specialized field. Finally, the community influentials are the political leaders,
university faculty, members of clergy, leaders of social or community organizations.

The transaction cost theory which was first initiated by Cyert and March (1963) and later
theoretically described and exposed by Williamson (1996) is an interdisciplinary alliance of law,
economics and organizations. This theory attempts to view the firm as an organization
comprising people with different views and objectives. The underlying assumption of transaction
theory is that firms have become so large they in effect substitute for the market in determining
the allocation of resources. In other words, the organization and structure of a firm can determine
price and production. The unit of analysis in transaction cost theory is the transaction, therefore
the combination of people with transaction suggests that transaction cost theory managers are
opportunists and arrange firms’ transactions to their interests (Abdullah & Valentine, 2009).
Tricker (2009) observes that this theory focuses on the cost of enforcement or check and balance
mechanisms, such as the internal and external audit controls, information disclosure, separation
of Board Chairman from CEO, risk analysis and the use of various board committees. Such

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enforcement costs should be incurred to the point at which the increase in costs equals the
reduction of the potential loss from non-compliance.
The political model of corporate governance on the other hand recognizes that the allocation of
corporate power, privileges and profits between owners, managers and other stakeholders is
determined by how governments favour their various constituencies. The ability of corporate
stakeholders to influence allocations between themselves at the micro level is subject to the
macro framework which is interactively subjected to the influence of the corporate sector
(Turnbull, 1997). Hence having a political influence in corporate governance may direct
corporate governance within the organization. The political model therefore highlights the
allocation of corporate power, profits and privileges being determined via the governments’
favor. Over the last decades national governments have been seen to have a strong political
influence on firms. As a result, there is an entrance of politics into the governance structure or
firms’ mechanism (Hawley & Williams, 1996). The key challenge here is the overdue influence
of the macro framework over the corporations which may not be in the best interests of the
corporation’s growth and sustainability goals.

Other than the fundamental corporate governance theories considered above, the second category
is that of ethical theories that are closely associated to corporate governance (Abdullah &
Valentine, 2009). These include business ethics theory, virtue ethics theory, feminist ethics
theory, discourse ethics theory, postmodern ethics theory. Business ethics is a study of business
activities, decisions and situations where the rights and wrongs are addressed. The feminist
ethics theory on the other hand emphasizes on empathy, healthy social relationship, loving care
for each other and the avoidance of harm. In an organization, to care for one another is a social
concern and not merely a profit centered motive. Discourse ethics theory is concerned with
peaceful settlement of conflicts. Discourse ethics refers to a type of argument that tries to
establish ethical truths by investigating the presuppositions of discourse. Virtue ethics theory
focuses on moral excellence, goodness, chastity and good character. Virtue involves two aspects,
the affective and intellectual. The concept of affective in virtue theory suggests “doing the right
thing and have positive feelings”, whilst, the concept of intellectual suggests “to do virtuous act
with the right reason”. Virtues can be instilled with education. Therefore if a person is exposed to

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good or positive ethical standards, exhibiting honesty, justice and fairness, then he would
exercise the same and it will be embedded in his will to do the right thing at any given situation.
Postmodern ethics theory goes beyond the facial value of morality and addresses the inner
feelings of a situation. It provides a more holistic approach in which firms may make goals
achievement as their priority, foregoing or having a minimal focus on values, hence having a
long term detrimental effect.

CHALLENGES IN CORPORATE GOVERNANCE

Corporations face various challenges in pursuit of their growth and sustainability goals. The
nature and extent of these challenges is, among others, rooted in the corporate governance theory
adopted by different corporate entities.
According to Letza (2002), the agency theory is faced with two challenges that occur in the
principal-agent relationship. The first is the difficulty or expense involved in the principal
monitoring the agent’s behaviour and routine actions. The second problem is that because of
their different attitudes towards risk by the principal and the agent, there are different preferences
by the two parties on how to address the corporation’s profitability and sustainability goals.
These problems lead to the ‘agency cost’ which is a particular type of management cost incurred
as principals attempt to ensure that agents/ act in principals’ interests. This scenario is discernible
among many micro, small and medium companies in Uganda. Possibly as an attempt to mitigate
the agency costs it is common to find owners preferring to assume the managerial function
themselves especially in family owned entities. However this attempt at merging the two
functions can only serve as an interim measure as its contribution to the corporation’s
profitability and sustainability is highly debatable. The more plausible solution would be to
focus on solving the above problems by determining the most efficient contract governing the
principal-agent relationship. Thorough determination of the most efficient contract governing the
principal-agent relationship is supported by Letza (2002) when he observes that in the agency
theory, all social relations in economic interaction are reducible to a set of contracts between
principals and agents. Contractual relations are the essence of the firm, not only between
shareholders, but also with employees, suppliers, customers, creditors, and other stakeholders.
He concludes that as the agency problem exists for all of the contracts, writing a contract must
provide safeguards for both the principal and the agent to align their interests. The key issue is

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the adoption of an optimal incentive scheme to align the behaviour of the managers with the
interests of the owners. In this respect, the most efficient contract is the trade-off between the
cost of measuring behaviour and the cost of measuring outcomes and transferring risk to the
agent.
The stewardship concept is common in not- for -profit Non Government Organizations (NGOs)
in Uganda and this may mainly be due to the fact that in most NGOs, some of the founder
members remain and serve in executive capacities in these organizations. It is therefore arguable
that in this case it is easy to align the organizational and top management’s goals. In this regard
the stewards are motivated when organizational success is achieved. This scenario is not
common in for-profit businesses where employment of managers from the outside is the norm,
which practice comes with a high probability of non alignment of the principal and agent’s
interests.
The stakeholder theory is traceable in the governance of public corporations in Uganda such as
the Uganda Investment Authority, the Uganda Wildlife Authority, Uganda Revenue Authority
and others with substantial government participation. In practice, the key challenge of the
stakeholder theory stems from its assumption that the corporation has a collective, rather than
individual identity and executives are representatives and guardians of all corporate
stakeholders’ interests. The reality in practice is that each stakeholder has competing objectives
and wields different power levels, it is therefore difficult to achieve equitable and collective
representation. In respect of corporations with shareholders, more power lies with those that
have bigger shareholding profiles and this influences top management’s decisions.
A sizeable number of both for-profit and not- for-profit corporate entities in Uganda employ the
resource dependency theory in appointing or electing their boards of directors. In doing this, their
key objective is to secure internal capacity comprised of people of different professional
backgrounds and experience. However a challenge emerges here in the form of ideological
clashes emanating from the different organizational culture backgrounds of the individual board
members. This state of affairs is prevalent particularly in young organizations that have not
consolidated their own organizational culture thus vulnerable to an influx of different and at
times conflicting governance approaches and views.
Corporations ran on the basis of the transaction cost theory which focuses on saving costs by
undertaking activities within the organization rather than externally, face operational challenges

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when the external market becomes cheaper. This theory is also based on the assumption that just
like in the agency theory, managers are given to opportunism and do act in their own best
interests and not necessarily those of the shareholders. The resultant institution of governance
structures and mechanisms mainly aimed at ensuring checks and balances by the owners over the
managers inevitably increases operational costs.
The political theory of corporate governance on the other hand is beset with disadvantages
accruing from excessive influence of government on private business which may not be
conducive to the business’s growth and sustainability.

CONCLUSION
While it is true that corporate governance practice is heavily influenced by the corporate
governance theory adopted by different corporations, it is also true that the challenges faced by
these corporations largely stem from the very nature of these theories. For the agency and
transaction cost theory - based corporations, the key challenge is the ‘agency cost’ which arises
from the difficulty or expense involved in the principal monitoring the agent’s behaviour and
routine actions. The solution here would be to focus on determining the most efficient contract
governing the principal-agent relationship. This should be determined by the trade-off between
the cost of measuring behaviour and the cost of measuring outcomes and transferring risk to the
agent.
Corporations practicing the stewardship theory in Uganda are mainly the not-for-profit
organizations where the ‘founder syndrome’ that involves founders and therefore would be
principals prefer to head management too. This challenge deprives the corporation of the benefit
of developing a professional and independent management cadre which ill can be solved through
separation of management from governance. Corporations compliant with the stakeholder,
political and resource dependency theories need to address the non convergence of different
stakeholders’ interests and views through deliberate and structured alignment of the varying
expectations. This is possible through rigorous pursuance of an independent organizational
culture built on shared values and practices.
Ethical theories closely associated with corporate governance focus on; the right and the wrong,
healthy social relations, peaceful settlement of conflicts, and moral excellence. This is with the
aim of supporting the governance of corporations in a way that can limit practices that may lead

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to business collapse. The adoption of these ethical theories in corporate governance practice is
premised on the realization that businesses have become a major provider to the society, in terms
of jobs, products and services and any business collapse has a greater impact on society than ever
before (Abdullah & Valentine, 2009).
Corporate governance challenges can be innovatively solved in order to take advantage of the
positive contribution made to corporations by good corporate governance theories and practice.
Considering the good attributes of the different corporate governance theories, it is plausible that
the associated corporate governance practices will instill in corporations the essential vision,
processes and structures to make decisions that ensure growth and sustainability of
organizations. However, corporations would benefit best if they do not rely on one corporate
governance theory but combine a variation of theories that enhance corporate performance. The
challenges experienced in a monolithic theory mode of corporate practice can best be confronted
and solved through a combination of theories that simultaneously ensure streamlining of
corporate structures and responsibilities, promotion of social relationships and also do emphasize
observance of rules, legislation and ethical values.

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