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Governance determines who has power, who makes decisions, how other players make their voice heard and how account is tendered."
2.1 CORPORATE GOVERNANCE
Corporate Governance is a relatively new term addressed in both public and academic debates despite the issues it deals with have been around for a long time, at least since Berle and Means (1932) and the even earlier Smith (1776). In present years, several questions related to the effectiveness and reliability of corporate governance in organizations has been subjects of heated debate. Wells (2010) stated that corporate governance was formed based on the likelihood of possible disagreement between investors and managers since corporations were created. Organizations always seek to further develop through market expansion and competition by making use of tools such as strategic management, business ethics and CSR, however, it is also imperative to have a good system of governance to be able to manage the relationship existing between the stakeholders of a company (Abdumavlonov, 2011). Tremblay (2012) studied governance in companies and argued that due to financial scandals of the last decade, more attention were given to the fight against fraudulent financial reporting and more responsibilities were added on the shoulders of the different stakeholders.
Table 2.1: Some cases of big international corporate scandals1980-2012
Name of Company
Nugan Hand Bank
Ernst & Whinney
Coopers & Lybrand
Polly Peck International
Coopers & Lybrand
Bristol - Myers Squibb
EL Paso Corp
Lehman Brothers Inc
Ernst & Young
Ernst & Young
Ernst & Young
Deloitte ,Touche, Tohmatsu
(Source: Adapted from Singh (2011), Wikipedia)
2.1.1 Definition of Corporate Governance
Throughout the years, corporate governance has been given different definitions by several authors. Ramon (2001) rightly said that it is not easy to give a universally acceptable definition of corporate governance as each country has its own culture, legal systems and historical development. Therefore, there are numerous ways of defining this concept. In the same way that the notion of corporate governance has been evolving from old times to modern age, its meaning is also changing at the same pace.
Table 2.1.1 Definitions of Corporate governance throughout the years
To conduct business according to owner's or stakeholders desires which is normally to make lots of money by following the legal and social rules of society.
Schleifer & Vishny
The way financers of firm expect profit from their investment.
An influence on the production of goods and services of a company.
A set of relationships between the company's management, its board, shareholders and other stakeholders.
A structure of rules and ethics that ensure enterprises are managed for long-term benefit of all stakeholders together with the preservation of their value over time.
The duties and responsibilities of the Board of Directors in managing company as well as the relationship between the shareholders and stakeholders.
Haslinda & Benedict
A set of processes and structures for controlling and directing an organization.
Crowther et al.
An environment of trust, ethics, moral values and confidence among the various stakeholders.
Most of the definitions of corporate governance are one dimensional as each definition analyzes only a specific aspect of governance. Most descriptions are about the way an organization is managed and controlled, but, there are also some which talk about other important features of corporate governance. The oldest definition of corporate governance was given by the economist Friedman in the 1970s. He focused mainly on the economic concept of maximizing market value. Later on, in 1997, Shleifer and Vishny's definition as well as Turnbull's definition of governance are quite shallow as the former laid emphasis only on providers of finance and the latter paid attention only to the production of goods and services. Later on, in 1999, OECD came up with a good definition which became a benchmark for defining corporate governance and has been widely used in many studies, in addition, in 2003; Williams further added an interesting part about ethics and preserving stakeholder's value over time to the meaning of governance.
2.1.2 Why is Corporate Governance important?
"The importance of corporate governance lies in its contribution both to business prosperity and to accountability." (Hampel Report, 1998) An organization which is correctly governed does not have to worry about corporate fraud, scandals and most importantly potential civil and criminal liability. Moreover, good corporate governance generates good reputation for an organization which in turn catches the attention of more customers, investors and even suppliers.
Earlier, it has been said that corporate governance refers to the way the Board of Directors supervise the work of managers in the running of a business and how the Board is also held answerable towards the shareholders, the company itself and also other stakeholders including the environment in which the business operates. Research proves that efficient management of governance, environmental and social issues creates a business culture and milieu that builds both a company's truthfulness within society and the faith of its shareowners (U.N. Global Compact and the International Finance Corporation (2009)).
2.1.3 The role of good Corporate Governance
Globalisation is making the world shrinking day by day which is in turn increasing mutual interdependence. In order to be successful, businesses all around the world are assembling the necessary resources and goodwill to obtain the trust of global financial markets and stakeholders.
In the same way, good corporate governance is about securing honorable and ethical relations between an organisation and its stakeholders. According to the ASX Corporate Governance Council (2003), good corporate governance will progress with shifting state of affairs of a company and must be modified to meet the new needs; therefore, best governance practices will evolve together with development.
Pande (2012) stated that while searching what good governance is made up of and promulgating the same, across organizations, there is the confidence that the former would certainly result in better performance of firm together with the proper steps to take in the interest of the various stakeholders. He also added that the perceptions that contribute to good corporate governance are:
Good corporate governance would protect the interest of the owners (shareholders) and harmonize the interests of the owners and managers.
Good corporate governance would result in better organizational performance and make it easy for firms to access external funds and investors.
In 1992, Sir Adrian Cadbury chaired a committee with the intention of examining the British corporate governance system due to the wave of corporate failures that occurred during that time. Later on in 1994, the publishing of the King report in South Africa had the main aim of supporting highest standards of corporate governance. Due to evolution in global economic environment and recent legislative development, the King report was updated in 2002; instead of only taking shareholders' benefit into consideration, the King report II endorses the economic, environmental and social aspects of a company's activities. In 2003, the ASX Corporate Governance Council came forward with an industry-wide supported framework of corporate governance in Australia. OECD reports (1998 and 2004) emphasize the characteristics of good corporate governance. Even present discussions involving corporate governance are still referred to these documents. And most recently, Latham and Watkins (2011) discussed a 12- step program to truly good corporate governance.
Table 2.1.3 Summary characteristics of Good Corporate Governance
King Report (2002)
ASX Council (2003)
OECD Report (2004)
Financial Reporting Council (2010)
Latham and Watkins
Lay solid foundations for management and oversight
Ensuring the basis for an effective corporate governance framework.
Principle goal of governance is value creation for shareholders.
Structure the board to add value
The rights of shareholders and key ownership functions.
Recognize that most corporate governance analogies to political, economic or legal theory are rhetorical devices, not answers.
Promote ethical and responsible decision-making
The equitable treatment of shareholders.
Corporate Governance policies not solely based on separation of Shareholders and Managers.
Safeguard integrity in financial reporting
The role of shareholders in corporate governance
No involvement in debate between short term and long term strategy and execution.
Make timely and balanced disclosure
Disclosure and Transparency
Relations with shareholders
Board's main role is strategic advisor and management supervisor.
Respect the rights of shareholders
Responsibilities of the Board
Limit Board size to enhance its effectiveness
Recognise and manage risk
Select nominees for Director for their key competencies.
Encourage enhanced performance
Select a good board leadership structure.
Remunerate fairly and responsibly
No unnecessary calls for regular shareholder votes in the name of accountability.
Recognise the legitimate interests of stakeholders
Remove the clutter of shareholder proposals from the Annual Meeting Agenda.
Liberate public companies from the restriction of one-size-fits-all Governance policies.
Investors voting with their feet are more efficient than imposition of one-size-fits-all Corporate Governance theories.
(Source: Adapted from Cadbury Report (1992), King Report II (2002), ASX Corporate Governance Council Report (2003), OECD Report (2004), Financial Reporting Council (2010) and Latham & Watkins (2011))
2.1.4 Environment and Key actors of Corporate Governance
Figure 2.1.4a derived from Ritson (2011), illustrate a concise version of a firm and its diverse environments in which it operates:
The internal environment
The operating environment
The broad environment
Fig 2.1.4a The different environments in which a firm operates
(Source: Adapted from Ritson, 2011)
Fig 2.1.4b below shows the groups or individuals who have a direct interest in an organization. They have a 'stake' in the company and they affect the objectives, strategies and activities of the organization. Different relationships are formed inside as well as outside the firm.
Fig 2.1.4b The primary stakeholders of a firm
(Source: Adapted from Ritson, 2011)
2.1.5 The different models of Corporate Governance
The Anglo-Saxon concept of governance has been mainly developed in UK and USA. It is the most dominant form of governance system around the world. The Anglo-Saxon model is portrayed by individuals and firms following their interest with a minimum government intervention. Moreover, the interests of shareholders and management come first before the benefits of other stakeholders. Critics have argued that this situation has led to a loss of the sense of community responsibility among many firms and has ultimately resulted in the requirement of codes of corporate governance. The exact opposite of the Anglo-Saxon model is the Latin model where the local community is given a lot of importance. In this model of governance, the sense of social responsibility is held high both among individuals and firms ( Crowther et al., 2011). Apart from these two models, there are many other models such as the Continental Europe model, the India model among others.
2.1.6 An overview of the fundamental Corporate Governance Theories
Fig. 2.1.6 Theories of Corporate Governance
(Source: Adapted from Haslinda & Benedict (2009), Zou & Cheng (2011))
2.1.7 Corporate Governance in Mauritius
Mauritius has always faced abuse of corporate governance power since the setting up of the first companies in the country. In the 1990s, when there was the disclosure of several corporate frauds, then, the term corporate governance came in public eye. Corporate governance was not even mentioned in Mauritius when the Mauritius Co-Operative Bank and Delphis Bank declared bankrupt due to unethical directors (Tulsi, 2006).
Furthermore, early 2000 also saw various business scandals among which big companies such as Air Mauritius and Rogers Co. Ltd was draining funds from their company leading to a fall in the price of their shares in 2002. The role of the internal and external auditors of both companies was highly questioned for not detecting such huge frauds (Roopun, 2004). The scandal involving these two companies had a negative impact on the image of the 'healthy' business environment of Mauritius. Later on, in 20003, the National Pension Fund (NPF) and the Mauritius Commercial Bank (MCB) also drew attention to another financial scandal in the finance sector where the bank indulged in malpractices concerning NPF's fixed deposit. This resulted in MCB's goodwill being fatally hit (Ramruttun, 2006).
Being greatly concerned about these scandals, the business community tried to find ways to control business practices. In order to be internationally competitive, it is important for Mauritius to display credibility and transparency. A series of major laws were introduced and amended and it was in 2001 that the NCCG was set up as the national coordinating body responsible for all corporate governance issues. This committee also makes sure that the level of corporate governance in Mauritius is up to world standard.
In Mauritius, corporate governance was first developed in the Anglo-Saxon context of separation of ownership and control of firms. A good system of corporate governance keeps equilibrium between the interests of the outside investors, the businessman and the management. In addition, there are other stakeholders whose welfare has to be taken into account, as does the sustainability of the business (Taylor, 2012).
The NCCG prepared a report on corporate governance also known as the code of corporate governance published in October 2003 and later revised in April 2004. The Report adopted the six principles of corporate governance as advocated by OECD. It was only on 30th June 2005 that companies started to comply with the code which covers the following areas:
Board of Directors
Auditing and Accounting
Risk Management, Internal Control and Internal Audit
Compliance and Enforcement
Integrated Sustainability Reporting
The Report emphasize that the code of governance applies to Listed Companies, Banks and Non-Banking Financial Institutions, large Public Companies, State-owned Enterprises and large Private Companies, however, the code is not binding. The Report states that all companies should give due consideration to the application of the Code and should disclose in their report the extent to which they are abiding by with the Code.
The World Bank carried out a ROSC in Mauritius in the beginning of 2012. As soon as the NCCG will receive the results, the committee will revise and re-initiate the Code. The NCCG hopes to increase the level of awareness of corporate governance in Mauritius through these activities (Taylor, 2012).
There are also many other legislation framework which have been created in the fight for stimulating good governance. The regulatory bodies like the FSC, FIU and FRC are responsible to keep an eye on the truth and fairness in financial reporting, the MIPA regulates the accountancy profession in Mauritius and the MioD promotes high governance standards together with inspiring ethical and good conduct of directors.
2.2 CORPORATIONS AND CORPORATE STRATEGIES
As soon as a corporation is formed, the law consequently identifies the existence of a legal entity that is completely separate from the organizers and investors, but, that can perform business activities like a 'person'(Blair, 2012).Shareholders are the owners of a corporation and the shares can be publicly or privately held (Murray, 2012).
The five distinct features of corporations according to Adams (2012) are:
Limited Liability - Shareholders are not liable to debts and liabilities of the corporation.
Perpetual Life - Corporations are considered have an endless life according to the going concern principle. There is no connection between the life of the corporation and its owners.
Transferability of Ownership - Shares of both private and public corporations can be transferred from one person to another.
Capacity to Contract - Corporations have the full legal right to enter into contractual agreements on their own behalf.
Centralized Management system - Shareholders appoint managers to take care of the day-to-day activities of the corporation.
Corporations usually finance their activities by using various methods. The sources of finance are either internal or external. Internal financing involved the company ploughing back its profit to re-invest in the company. External sources of finance are in the form of issuing debts and equities or a combination of both.
Corporations have a CEO, MD, ED or CE alongside top management who are responsible for the daily operations and strategy-making. The shareholders (owners) are normally large in numbers sometimes lack the necessary skills and expertise; therefore, they are represented by a Board of Directors who are experts and has the know-how of the different aspects of business. The Board of Directors is elected by shareholders in Annual General Meetings and the board in turn appoints a CEO (Wikipedia, 2012). Fig 2.2.1 shows this concept of centralized management.
Fig 2.2.1 Centralized Management System
Table 2.2.1 illustrates the indispensable distinction among the duties of the Shareholders, CEO/Top Management and the Board of Directors.
Table 2.2.1 Different duties of shareholders, Board of Directors and CEO
Invest in company
Do not participate in day-to-day activities of company
Interested only in profitability of company
Act as the principal
Board of Directors
Act on behalf of shareholders to monitor activities of the company
Do not participate in day-to-day activities of company
Make sure that company is being well managed and take corrective actions when necessary
Help CEO/Top management with strategy-making
Responsible for day-to-day running of the business
Make strategic decisions to maximize value of shareholders
Act as the agent
(Source: Wikipedia, 2012)
The CEO and Top Management devise the mission and vision of an organization. They craft specific goals and objectives and formulate strategies to be able to attain these goals. These strategies are then passed on to middle and lower level management for implementation. High level management also lays policies, rules and regulations which must be followed by lower level management.
2.2.2 Corporate Strategy
Any decision-maker in any organization seeks to make the company a successful one, in this respect, it is vital to make a good strategic decision. Strategy differs from a company's vision, mission, goals or plan, strategy can be defined as the choices made by high level management on how to carry out business and be successful by maximizing long-term value. Strategy can be broken down into two parts namely; choosing the right place to conduct business and taking the right initiative to provide customers with what they want (Favaro et al. 2012).
There are different levels of strategy in an organization which are the corporate strategies, Business/Competitive strategies and Operational/Functional strategies (Ritson, 2012). Each of these strategies are different from each other and occur at different levels of management, however, they function together as one for the smooth running of an organization.
Corporate strategy affects the foundation of an organization and its line of business through future planning and structuring (Ritson, 2012). In simpler terms, corporate strategy relates to the overall purpose and scope of an organization to meet the expectations of stakeholders. Shareholders heavily influenced the strategic decision making throughout an organization (Riley, 2012). A corporation will normally through corporate strategy allocate its resources in the best possible way to increase its level of activities, therefore, performing better and ultimately increase the value of shareholders. An organization can use various means to enhance the value of the business which are:
New business initiatives
Mergers and acquisitions
Strategic alliances and joint-ventures
Strategic matters faced by a corporation differ from that of other type of business. A corporation is concerned with the company as a whole and practically all corporations (excluding non-profit) are profit maximisers, thus, they will always look for profitable schemes, expansion or diversification. The three dimensions of corporate strategy are Business Diversification - Horizontal expansion, Vertical Integration - forward or backward expansion and Geographic Scope - geographic and/or global expansion (Collis et al, 1998).
For an organization to be successful in implementing corporate strategies there should be commonly complementarities between the role of the CEO/Top Management and the Board of Directors. These complementarities of roles guarantee that the corporate governance system and the corporate strategy system are mutually inclusive of each other (Ahmed & Najam, 2006).
Tactics is the art of using troops in battles;
Strategy is the art of using battles to win wars.
2.3 THE AGENCY THEORY THE STAKEHOLDER MODEL OF CORPORATE GOVERNANCE AS A BASIS FOR UNDERSTANDING THE LINK BETWEEN CORPORATE GOVERNANCE AND CORPORATE STRATEGIES
2.3.1 The Agency Theory
The basic principle behind the agency theory is the principal-agent problem which arises between the owners of a company and its management. The shareholders are the principal who invest their money and resources in the business and the managers are the agents who take care of the running of the business. There has been many times where conflicts have arisen due to differences in the objectives of the two parties.
The agency theory shareholders expect the agents to act and make decisions in the principal's interest. On the contrary, the agent may not necessarily make decisions in the best interests of the principals (Padilla, 2000). The agency theory was introduced basically as a separation of ownership and control (Bhimani, 2008). Indeed, agency theory can be employed to explore the relationship between the ownership and management structure. However, where there is a separation, the agency model can be applied to align the goals of the management with that of the owners.
Hires and delegates
Fig 2.3.1 The Agency Model
(Source: Adapted from Haslinda & Benedict, 2009)
In view of Franklin K. et al. (1989), Agency theory is regarded as problem-solving theory in some situations of corporate conflict. It can resolve two areas of problems that occur in agency relations:
Agency theory plays vital role, when conflicts arise between the principal and agent. In some cases where it is difficult or expensive to determine for the principal to analyze what actually and exactly agent is doing.
Secondly, agency theory can be important, when it is seemed that risk of sharing information between agent and principle. It normally occurs when both agents and principal have different attitude and preference toward risk.
Summing up, Principal and Agent are two streams of agency theory. These streams also provide common assumptions about stakeholders of organization. Jensen (1983) further discusses the mechanism of governance in problem solving route and principal agent stream engage with general kind of theory that can be applied in creation of relations between employer & employees, lawyer & client, buyer & customer and others. Typical principal-agent relationships (between shareholders and management) are seen as subset of a number of stakeholder-agency relationships.
2.3.2 The Stakeholder Model of corporate governance
Models of governance can either be shareholder-oriented or stakeholder-centered. The former related to the outsider system of governance while the latter is the insider system. Proponents of the outsider model accept the opportunistic tendencies of management and recognize the divergent goals of shareholders and management. Governance structure in an outsider model all aim at better serving the interest of shareholders (Garcia et al., 2008).
The fairly new stakeholder model compared to the traditional shareholder model, views a corporation as a convergence of responsibilities towards the other stakeholders' welfare instead of only looking after the shareholders' prosperity. Employees, creditors, customers, suppliers and the society at large are major and important stakeholders which are widely mentioned in wide definitions of stakeholders (Ayuso et al., 2007).
In simpler terms, the insider model is about giving priority to stakeholders' control. Insider model of corporate governance is mostly based on an interest of stakeholders and often ownership is concentrated (shares owned by family, banks or institutions) by aiming to reach long term goals (Abdumavlonov, 2011).
This model provides an in-depth insight about the major actors and their influences in an organization's corporate governance and strategic framework. It gives a basic parameter to study information flow and behavioural impact of key constituents in an organization and who are the potential users of the information. The external environment of a firm consists of its stakeholders who either directly or indirectly have an interest in operations and results of the company. The stakeholders can play vital role in boosting overall performance of corporation.
2.3.3 The connection between the Concept, Theory and Model used
The frame of reference comprising of agency theory and stakeholder model highlights the internal and external forces affecting an organization's strategic decision making. This framework taken in unison indicates that the entire process entails constant information flow and feedback thus leading to decision making at the top - which in turn affects strategy of the organization. This framework prominently identifies key stakeholders at intra-organizational and external who have overlapping as well as conflicting motivation and varying dependencies amongst key constituents of the system. While segregating authorities, responsibilities and boundaries of involvement, it also brings into account the motivational and behavioral aspects.
This framework helps to understand that corporate strategy is a function of different domains, layers, and personalities. It is a highly interactive process. Apart from numbers and performance, corporate strategy is highly dependent upon various factors, market forces and internal flow of information, assimilation, action and behavioral aspects of decision makers. Strategy can thus be regarded as a function of combination of these forces. When the organizational system as a whole resorts to questionable practices and collapses due non-conformity to acceptable practices, norms and values, it is regarded as failed corporate governance.
Since firms have got different ownership setup, operate in different industries, with different regulatory and statutory framework hence it is difficult to have a consolidated corporate governance theory. In this study, the Concepts, Theory and Model are merged in a way to get accurate picture of corporate governance's effects on strategy of corporations. This prompted the hypothesis that corporate governance has an effect on corporate strategy. Corporations are highly complex organizations, having their own industrial dynamics and are dominant actors in the economy of a country. Their inception, survival, growth and decline are interlinked with many determinants. These factors provide direction for the study in a way that helps in attaining desire task. Hence, the Agency Theory and the Stakeholder Model have been used evaluate how corporate governance effects strategy of corporations by using.
2.4 EMPERICAL EVIDENCES
Various studies have been carried out regarding corporate governance, its definition and origin, its impact of the on the strategic decision making. The principles underlying the agency theory has also often been used as a reference. Each researcher had used different approaches to conduct their research and had reached a conclusion of their own.
Nerantzidis (2012) carried out a research on the definitions of corporate governance by analyzing 22 definitions from the years 1992-2010. He used the technique of snowball sampling to collect his data online and developed a six-dimensional framework (the institutional dimension, the shareholder dimension, the governance dimension, the control dimension, the performance dimension and the stakeholder dimension) based on the 22 definitions. He finally concluded that the definitions of corporate governance mostly used are very narrow; either two or three dimensional do not fulfilled his six-dimensional framework.
A survey carried out by Mac Kinsey and Co. found that investors pursuing a growth strategy did not worry by corporate governance, but investors who pursued value strategy and invested in under-valued or stable companies were willing to pay for good governance. These investors have a belief that a company with good governance will perform better over a period of time and that good governance can reduce the risk and attract further investment (Agrawal et al. 1996).
A recent study carried out in Brazil pointed out that corporations are facing a series of challenges to enhance their competitiveness and increase their market share. In order to continuously raising their levels of performance and consequently their market value, they act in accordance with the principles of good corporate governance, and behave in an ethically and socially responsible way towards all their stakeholders. The investigation examined a non-probabilistic sample of public corporations and the research adopted the multiple linear regression method, which was applied to a secondary data base. The result suggested that the improvement in corporate governance practices has already had an impact on the value of public corporations whose shares have significant levels of liquidity and price volatility (Anon, 2012).
Ayuso et al (2007) investigate the stakeholder approach to corporate governance. They studied a sample of international big companies to find out if stakeholders involvement in the companies really lead to improve financial performance. They concluded that depending on a country's legal practice, the commitment of stakeholders have a positive effect on firm performance.