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This chapter focuses on the theoretical background of Corporate Governance as it explores the multiplicity of the existing writings on CG. It also gives a better idea to what has been said and found by previous studies as well as an insight of the empirical evidences which support the studies and findings of researches.
Concept of Corporate Governance
Corporate Governance has no universally accepted definition but it is defined accordingly in relation to the different aspects pertaining to the perspective of different researchers, context, and the cultural situations. In the words of Wilcox et al., (2012), CG is defined as the "proper allocation of power and responsibilities among the board of directors, the management and the owners of a business." The authors discussed that their definition identifies sets of external and internal rules as internal procedures are vital sustain efficient relationships with stakeholders and also revealed that CG is primarily in associated with listed companies.
On the other hand, the Financial Times Lexicon (2010) described CG as the way in which a company is being managed such it ensures accountability as well as sound ethics and the concept includes such as disclosure of information to shareholders and board members, remuneration of senior executives, potential conflicts of interest among managers and directors, supervisory structures. Additionally, in 2006, Wilson defined CG as the manner in which corporations are directed, controlled and held to account with special concern for effective leadership of the corporations to ensure that they deliver on their promise as the wealth creating organ of the society in a sustainable manner. In the same context inculcating the concept in a business context, Jayashree (2006) explained CG as a system of making directors accountable to shareholders for effective management of the companies in the best interest of the company and the shareholders along with concern for ethics and values that is CG is the management of companies through the board of directors who concentrate on complete transparency, integrity and accountability of management.
A more comprehensive definition by John and Senbet (1998) revealed that CG deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. The results encompassed stakeholders, shareholders, and also debt holders along with non-financial stakeholders such as employees, suppliers and customers. Hart (1995) firmly shared this idea that CG issues arise when there are two conditions in an organization that is there is an agency problem or conflict of interest, involving members like owners, managers, workers or consumers of the organization and transaction costs are such that this agency problem cannot be dealt with through a contract.
Claessens (2003) argued that CG falls into a 2 sets which are behavioral patterns and normative frameworks where the former refers to the actual behavior of firms in terms of performance, efï¬ciency, growth, ï¬nancial structure, and treatment of shareholders as well as stakeholders. The second set is concerned with the rules coming from such sources as the legal system, the judicial system, ï¬nancial markets, and factor (labor) markets under which corporations are operating while the OECD (2004) contended that CG "involves a set of relationships between a company's management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring."
From the array of definitions, it is observed that CG is a vital component for the survival of corporations and CG will be present in organizations as it is a keystone used by companies to achieve their goals. In addition, there are various common features which can identified as most of the definitions provided by the different researches reveal that CG is about observing and controlling the operations of firms while protecting shareholders as well as highlighting the importance of board of directors and components such as honesty, trust and integrity, complete transparency, accountability and responsibility, protection of stakeholders interests and satisfaction, participation, business ethics and values, performance orientation, openness, mutual respect and commitment to organization are quite convincing that sincere compliance or adherence to them would pave way for the sustenance of business corporation, realization of corporate goals, good and appreciable turn out and a veritable global market place. http://books.google.mu/books?id=5Z0oodUD_6EC&printsec=frontcover&dq=key+dimensions+of+corporate+governance+2012&hl=en&sa=X&ei=q8obUfreOMLSrQfppYHgCg&ved=0CDAQ6AEwAQ#v=onepage&q&f=false (pg 10) New definition
Theories of Corporate Governance (Wednesday)
In order to understand the relationship among shareholders, board members and top management also referred to as the three key stakeholders of CG, the agency theory remains a fundamental aspect (Roche, 2009). Jensen and Meckling (1976) defined the agency relationship as a contract under which one party (the principal) engages another party (the agent) to perform some service on their behalf and Abdullah and Valentine (2009) refined the definition as being "the relationship between the principals, such as shareholders and agents such as the company executives and managers" In simple words, the theory refers to a situation where the owners (shareholders) of a firm also known as the principal appoints directors or managers (agents) to perform the activities of the firm and to take decisions on their behalf. Highlighted by Brink (2011), the agency theory also known as the principal-agent theory deals with a challenging relationship arising from the separation of ownership and control.
Jensen and Meckling (1976) argued that this theory reduces the value maximizing decisions taking by the manager in the firm while on the contrary Himmelberg et al., (1999), claimed that the principal agent problem are not similar in all firms rather they are vary among different firms, industries and cultures. Based on these authors theory, McColgan (2001) gave a very broader view of agency theory and corporate governance where he discussed that the agency relationship and the agency cost which arises from the principal- agent relationships. The latter agreed that the agency problem can be reduced by the help of effective corporate governance mechanism which can be important in reducing the agency cost and the ownership problems in the firms. The governance should be design according to the firm environment as one general mechanism can be more important for some firms and less important for other firms
On the other hand, according to Mallin (2004), a company's management becomes more powerful when the company's shares are mostly held by the board of directors which is comprised of individuals who do not have much information on related to the firm that is a company's management should have a significant ownership of the firm in order to ensure a positive relationship between corporate governance and the amount of shares owned by the management. Wheelen and Hunger (2002) argue that problems arise in corporations because agents (top management) are not willing to bear responsibility for their decisions unless they own a substantial amount of stock in the corporation.
Eisenhardt (1989) argued that agency theory is concerned with analyzing and resolving problems that occur in the relationship between principals (owners or shareholders) and their agents or top management while Blair (1995) contended that the theory rests is based on the assumption that the role of organizations is to maximize the wealth of their owners or shareholders.
Idowu and Louche (2011) also added that this theory concludes that shareholders should seek to enhance monitoring and control of management and align the incentive of managers with those of shareholders in order to keep managers focused on value creation.
Agency theory is defined as "the relationship between the principals, such as shareholders and agents such as the company executives and managers".
Agency theory refers to a set of propositions in governing a modern corporation which is typically characterized by large number of shareholders or owners who allow separate individuals to control and direct the use of their collective capital for future gains.
Sims (2003) identified two different categories of stakeholder groups namely primary and secondary stakeholders groups and both groups are vital to the organisation. The first group consisted of shareholders, investors, employees, customers, suppliers and community while on the otherhand the secondary group consisted of interested groups such as media, government and regulators, social pressures groups and trade associations.
Therefore, the objective of the stakeholder theory is to tighten the relationship between the stakeholders and the firm. Emphasis should be put on various stakeholders on whom the company relies on. It is also assumed that managers have a duty towards all stakeholders including shareholders.
Good Corporate Governance (Thursday)
Principles of Corporate Governance
The Business Roundtable (1997) stated that "Good corporate governance is not a 'one size fits all' proposition, and a wide diversity of approaches to corporate governance should be expected and is entirely appropriate. Moreover, a corporation's practices will evolve as it adapts to changing situations." However, the 'one size fits all' approach was rejected by the OECD (1999) which revealed the need for pluralism, flexibility and adaptability in corporate governance
The principles of corporate governance have been developed as guidelines rather than rules which could be used across different countries and markets (Gul & Tsui 2004b). Worldwide organizations such as the World Bank, APEC and the OECD encouraging corporate governance to boost economic growth insist on the governance principles. The main focus of the OECD came up due to the separation between ownership and control of capital and even if they had a limited concentration, they were comprehensive to the voting rights of institutional shareholders as well as obligations of the board to stakeholders. Building up on the OECD guidelines, the APEC principles focused on disclosures and grouped the responsibilities of shareholders, managers and directors while establishing accountability as a separate principle (Fernando, 2006). Governance is not simply a relationship between shareholders and management but stakeholders such as employees and creditors also have their rights.
Highlighted by Buchan (2013), the Australian Stock Exchange (ASX) identified eight basic principles where companies should (i) lay solid foundations for management and oversight, (ii) structure the board to add value, (iii) promote ethical and responsible decision-making, (iv) safeguard integrity in financial reporting, (v) take timely and balanced disclosure, (vi) respect the rights of shareholders, (vii) recognize and manage risk and (vii) remunerate fairly and responsibly. It was also pointed out that corporate governance is a system by which companies are directed and managed. According to recommendation of the ASX corporate governance principles, companies should have a board of an effective composition, size and commitment, to adequately discharge its responsibilities and duties (ASX Corporate Governance Council 2003). The ASX guidelines were criticized as to whether a majority of independent directors is the best way to serve the interest of the shareholders and Connors (2003) suggests that the issue of independence is highly overrated".
Table 2.1: Principles of Corporate Governance
OECD Key Parameters
Asia Pacific Economic Cooperation (APEC) principles
Their rights to attend and participate in AGMs, to elect Board members, to receive dividends and to avail relevant, timely, regular and accurate information
Right to transfer shares
To know capital structures and arrangement that confer on some members, disproportionate controlling rights
Corporate control mechanism should function efficiently and transparently; accountable management
Establishment of rights and responsibilities of all shareholders
Equitable treatment of Shareholders
All shareholders including minority and foreign shareholders receive equitable treatment.
Effective redressal for rights violations.
Change in voting rights subject to their vote.
Prohibition of insider-trading and self-dealing
Directors to avoid decisions concerning own interests.
Equitable treatment of all shareholders
Role of Stakeholders
Recognition of their rights as established by law.
Encourage their active cooperation in creating sustainable enterprises
Permit performance enhancing mechanisms.
Access to relevant information.
Establishment of effective and enforceable accountability standards.
Disclosure and transparency
Accurate and timely disclosure on company objective; major share ownership and voting rights; financial and operating results; directors and key executives and their remuneration; significant foreseeable risk factors; governance structures and practices; material issues regarding employees and other stakeholders
Timely and accurate disclosure of financial and non-financial information with regards to company performance.
Responsibilities of the Board of Directors
Specify key responsibilities of the Board-overseeing the process of disclosure and communication, monitoring the effectiveness of governance practices and change them, if necessary
Formation of Board of Directors and deciding their remuneration
Adapted from: Corporate Governance: Principles, Policies and Practices
Corporate Governance indices
Implementation of CG
http://www.kfw-entwicklungsbank.de/ebank/EN_Home/Sectors/Financial_system_development/Events/Inhaltsseite/Session_4_-_Klaus_Maurer.pdf Pg19 chart