There is no single definition of corporate governance. Definitions vary from country to country, but all these tend to fall along a spectrum according to whether a 'stakeholder approach' or 'shareholder approach' to business is used. The Cadbury Report (1992) defines corporate governance as the system by which companies are directed and controlled. The stakeholder approach is dominant in Germany and Japan while the shareholder approach is dominant in Anglo-American countries like the United Kingdom and the United States of America. This paper looks into the range of perspectives that attempt to define the corporate governance structure of firms.


According to Parkinson 1994, corporate governance may be defined as '... the process of supervision and control intended to ensure that the company's management acts in accordance with the interests of shareholders.' Corporate governance arises from the need of separation of ownership and management. The shareholder theory is a narrow financial and economic perspective. The stakeholder theory takes into account a wide array of disciplines as opposed to focusing on shareholders alone. This paper analyses various models of a firm by looking at the different views and perspectives presented by each in comparison to the current frameworks. Each model offers its own reasons for shortcomings in corporate governance and tries to propose solutions for the best model possible.

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The paper is organised as follows: Section 1 explores theoretical issues relating to the models of the firm and compares the main models. Section 2 presents the contrasting views of the theories reviewed. Section 3 discusses descriptively the current corporate governance frameworks. The paper concludes with a suggestion of what would be deemed as the most suitable model and gives prospects of any improvements to the current theoretical models.



The Shareholder perspective is also known as the Agency theory. In this theory, the aim of a firm is to maximise shareholders wealth. The major problem in this theory is the dispersion of share ownership and separation of ownership and control (Berle and Means, 1932). Shareholders' actually own the company and delegate the day to day running of company business. Jensen and Meckling (1976) defined company managers as 'agents' and the shareholders as 'principal'. The theory assumes conflicting interests of the agents and the principals. This results in tendency to focus on short term high end profits rather than long term maximisation of shareholder wealth. Short-termism has been defined as a tendency to foreshorten the time horizon applied to investment decisions, or raise the discount rate above that appropriate to the firm's opportunity cost of capital (Demirag and Tylecote, 1992). Any finance investment that is expected to improve the value of shareholders stake in business is deemed acceptable.

It is difficult for the shareholder to exercise control over company management since it would be both costly and time consuming. The difference in the interests of the principal and agent will unavoidably generate costs. Additional meetings with the shareholders may lead to the company incurring more costs on resources. In this regard, most companies initiate policies where incentive schemes and contracts are used. Contracts aim at re-aligning the interests of the shareholders to those of the agents. The theory claims that corporate governance failures are best addressed by removing restrictions on factor markets and the market in corporate control, together with strengthening the incentive system (bonuses, stock options, etc) introducing a voluntary code and appointing non executive directors. (Letza, et al)

Shareholder theorists are against any form of intervention by the government. They prefer to have a laissez-faire setup where the firm is left to run on its own principles and structures.

In this perspective, there is information asymmetry between the shareholders and managers. Since the managers are involved in the actual running of the company, they would have more information than the shareholders. The shareholders rely on information from managers who can only give what is favourable to them thus creating an information imbalance between the two parties. The shareholder model is used in Anglo-American countries, for example the United States of America (US) and the United Kingdom (UK). UK and US boards lack engineers and scientists, and thus the decisions made are not usually well advised by experts and specialists.


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The Stakeholder Theory, according to Freeman (1984) holds that the firm should serve interests of a wider range of stakeholders including the government, employees, customers and suppliers, instead of only concentrating on shareholders. He proposed a general theory of the firm incorporating corporate accountability to a broad range of stakeholders. Some extreme proponents of this theory suggest that the environment, animal species and future generations should be included as stakeholders (Solomon, p. 23).

The idea of corporate social responsibility is closely linked to the stakeholder theory. Companies are being actively encouraged by social and environmental lobby groups to improve their attitudes towards stakeholders and to act in a socially responsible manner (Solomon, p. 24). Managers should first attend to their moral duties and obligations before focusing on maximisation of shareholders wealth. Stakeholder theory claims that whatever the ultimate aim of the corporation or other business activity, managers and entrepreneurs must take into account the legitimate interests of those groups and individuals who can affect (or be affected by) their activities (Donaldson and Preston 1995, Freeman 1994).



Stakeholder theory is the necessary outcome of agency theory and is thus a more appropriate way to conceptualize theories of the firm (Solomon, p. 27). The shareholder theory mainly aims at satisfying shareholders while the stakeholder theory opines that in addition to shareholders, the firm should strive to satisfy other stakeholders as well. The shareholder theory may then be seen as the narrow form of the stakeholder theory.

In the shareholding perspective, the firm is owned by the shareholders. Therefore, the sole purpose of the firm should be maximisation of shareholders' wealth. If firms choose to undertake other social responsibilities, there will be loop-holes for managers' to abuse the powers given to them. According to Friedman (1962, 1970), the only social responsibility of a firm is to increase its profits. He assumes that if society has outlined most moral and ethical standards with corporate law, then the company's obligations to non-shareholders will be fulfilled with lawful business practices. Therefore the purpose of a firm should solely be profit maximisation in accordance to the law and business ethics.

Another issue to be addressed is the protection of shareholders' interests. It is difficult and expensive for the principal to monitor the agents' behaviour and also the two may differ on opinions regarding governance. The shareholder theories assume that there is a risk of managers serving their own interests. Managers have a wide range of motives. It is also their objective to gain recognition, intrinsic satisfaction of good performance and success, respect for authority and work ethic. As Quinn and Jones (1995) explained, adopting the shareholder perspective would lead to a discourse based on self interest, whereas adoption of the stakeholder perspective leads to a discourse of 'duty' and social responsibility. Unless these perspectives can be merged in some way, the managerial discourse cannot be expected to combine fully the extremes of profit seeking, self interest and moral responsibility to society.

In terms of market efficiency and governance, shareholder theorists infer that maximisation of share prices best serves the shareholders wealth. If a firm is performing well, its share price will increase. This is not the case though when the firm is performing poorly, since share prices will fall allowing an opportunity for institutional investors[1] to buy their stocks cheaply and eventually take over. Ignoring the needs of stakeholders can lead to lower financial performance and even corporate failure (Solomon, p. 29).

The stakeholder theory suggests that stakeholders of importance are those essential to the very existence of the firm. Theories of the firm must uphold an implicit moral minimum that includes certain fundamental rights and principles and assumptions of human behaviour that may very well require other traditional theories of the firm to be modified or even reconceived (Solomon, p. 27). Although the ultimate goal of the firm is to maximise profits, satisfying the needs of a wider group of stakeholders can also lead to satisfaction of this objective. Managers must strive to develop relationships while at the same time motivating their stakeholders, so as to create an environment where everyone strives to give their best in order to deliver the value the firm promises. If all stakeholders are taken into account, scandals such as 'Enron', 'Parmalat' and 'Worldcom' could be prevented from happening.


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The Myopic Market Model agrees with the shareholder theory, that the firm's main focus is maximisation of shareholder wealth. However, according to Clarkham (1994), Sykes (1994), Moreland (1995), they argue that the shortcoming of the Shareholder theory is the short term market value. The short sighted markets force managers to concentrate on current share prices without taking into account the long term investments of the firm. The interest of the agents is to pursue their own selfish goals. These include getting the highest possible bonuses and increasing their salaries. In Anglo-American countries such as The United States of America and the United Kingdom, the main source of funding is through equity as opposed to debt. The equity type financial assets include shares, investment trusts and marketable bonds. The nature of these funds is mainly on short term basis.

The Abuse of Executive Power model is based on the stakeholder theory and can be used to describe some of the corporate governance practices. This model disagrees with the 'principal-agent' theory. It argues that the purpose of a firm is to serve the corporate interest as a whole as opposed to maximisation of shareholders wealth only. According to this theory, shareholder power is limited in practice and as a result, managers' behaviour based on self discipline is ineffective. It calls for, more powers for non executive directors, in addition to their independent nomination.

Corporate governance practices in Japan strongly tend towards the stakeholder theory. Provision of funds is mainly through borrowing from banks. Corporations rely heavily on debt financing and this is characterised by bank borrowing under the "main-bank" [2]system, a form of close and continuous bank-firm relationship. Maintenance of close relationship with a bank means that the firm can count on timely and flexible borrowing from the bank. Hence it is not necessary for the firm to maintain large amounts of internal funds at hand. In this kind of bank-firm relationship, there is free flow of information thus reducing information asymmetry. This may reduce the cost of funding for the firm since the risk premium of the borrowing rate is reduced.


My preferred model would be the stakeholder model. If the firm strives to satisfy all stakeholders, then consequently their profits will increase. Firms should put more emphasis on social factors including emphasis on families, employment of physically disabled and ease of work for women. Other factors affecting stakeholders that can be taken into account are consumer orientation, support for society, environmental preservation, improvement of infrastructure and disclosure. Taking into consideration all other stakeholders will benefit the corporation immensely in terms of reputation and its work towards social responsibility.

In terms of funding, the firm should balance both equity and debt. Heavy reliance on debt may give the lending institution excessive power over the corporation. On the other hand, over reliance on the stock market is risky since financial asset prices and interest rates are unpredictable. Instead of the firm being a profit making venture, it should be an avenue for shareholders and stakeholders to develop morally and materially through the relationships they establish. Managers should strive to make a contribution to the economy at large. At no point in time should self-interest supersede the interests of others. Serving the interests of all the stakeholders will contribute to their long term relationships with the firm.


Both the shareholder and stakeholder theorists claim superiority of their models. However, from the above discussion, none of the models is mutually exclusive of the other. There seems to be a shift from share holding to stake holding and vice versa. As seen, the stakeholder theory may be expressed as a wider version of the shareholder theory and therefore it cannot be said that they are independent. The stakeholder perspective simply takes into account a larger group of stakeholders as opposed to the shareholder perspective whose main focus is the shareholders. The firm being a human institution should have several members and not one owner. It can therefore be concluded that the stakeholder perspective is better as it considers a larger group of stakeholders. It has been noted that this perspective focuses on long-term relationships as opposed to simply maximising profits which may be through short term ventures.


1. Berle, A.A. and Means, G.C. (1932), The Modern Corporation and Private Property, New York: The Macmillan Corporation

2. Cadbury Committee (1992) Report of the Committee on the Financial Aspects of Corporate Governance. London: Gee

3. Clarkham, J. (1994) Keeping Good Corporation: A study of five countries. Oxford: Clarendon

4. Deakin, S. and Slinger, G. (1997) Hostile Takeovers, Corporate law, and the Theory of the firm, Journal of Law and Society, 24, 124-151

5. Demirag, I. S. and Tylecote, A. (1992), The Effects of Organisational Structure, Culture and Market Expectations of Technological Innovations. A Hypothesis'. British Journal of Management, Vol. 3, No. 1, pp 7-20

6. Donaldson T., and Presston L., (1995), The stakeholder theory of the corporation; Concepts, evidence and implications, Academic Management Review20 (1)65-91

7. Freeman, R.E. (1984), Strategic Management: A Stakeholder Approach. Boston: Pitman Publishing

8. Friedman, M. (1962), Capitalism and Freedom, Chicago: University of Chicago Press.

9. Friedman, M. (1970), ''The social responsibility of business is to increase its profits'', The New York Times Magazine, September 13, 32-33, 122, 124, 126.

10. Jensen, M. C. and Meckling, W. H. (1976), ''Theory of the firm: managerial behaviour agency costs and ownership structure'', Journal of Financial Economics, Vol. 3 No. 4, pp. 305-60.

11. Letza, S., Sun, X. and Kirkbride, J, "Shareholding versus Stakeholding: A Critical Review of Corporate Governance", Corporate Governance: An International Review, Volume 12, No. 3, pp. 242-262

12. Mitsuaki Okabe, (2004) , "The Financial System and Corporate Governance in Japan", Policy and Governance working paper series no. 17

13. Parkinson, J.(1994), Corporate Power and Responsibility, Oxford: Oxford University Press, 1994.

14. Quinn, D. P. and  Jones, T. M. (1995): 'An Agent Morality View of Business Policy', Academy of Management Review 20, 22-42

15. Slinger, G. (1998) Spanning the Gap: The theoretical principles that connect stakeholder policies to business performance. Working paper 111, ESRC Centre for Business Research

16. Sykes, A. (1994) Proposals for internationally Competitive Corporate Governance in Britain and America, Corporate Governance, 2, 187-195.

17. Solomon, J. and Solomon, A. (2004), Corporate Governance and Accountability, John Wiley & Sons, Chichester Publishing Co., New York, NY

[1] Institutional investors are specialised financial institutions that manage savings collectively on behalf of small investors towards a specific objective in terms of acceptable risk, return maximisation and maturity of claims (Davis and Steil, 2001). Typical institutions include pension funds, life insurance companies and investment trusts.

[2] The "main-bank system is where banks provide not only short term but also long term funds. This may be through loan or by acquiring corporate bonds and equities issued by corporations; so that firm's dependency on the bank is high. Banks may often acquire stock issued by the client firm and hold that stock in 'stable' manner. Accordingly a bank is both lender and shareholder for the client firm, so that the bank participates in the management of the firm in both capacities. Thus corporations are said to be monitored and disciplined by banks as opposed to the stock market (Okabe, 2004).