Theoretical Aspects of

Corporate Governance

No Single Universal Theory

Development of corporate governance is

a global occurrence, and

a complex area including legal, cultural, ownership, and structural
differences

Thus, some theories might be more appropriate and relevant to some

countries than others
Or, more relevant at different times depending on what stage an
individual country, or group of countries, is at

Theories Associated with the

Development of Corporate
Governance

There are 4 main theories that have affected the development of

corporate governance:

Agency Theory

Transaction Cost Economics

Stakeholder Theory

Stewardship Theory

Agency Theory
(Principle-Agent Framework)

Agency theory identifies the agency relationship where one party, the
principle, delegates work to another party, the agent.

Disadvantages:

The opportunism or self-interest of the agent; he/she does not act in

the best interests of the principle, or acts partially in the best
interest of the principle.
Information asymmetry; agent has more information.

The Agency Theory Corporate Governance

Agency theory views corporate governance, especially the board of

directors, as being an essential monitoring device to try to ensure that
any problems that may be brought about by the principle-agent
relationship, are minimized.

Aspects of the Agency

Theories

Parties (in corporate governance context):

Mangers (agents)

Owners (principles)

Managers must be monitored and institutional arrangements must provide

some checks and balances to make sure they dont abuse their power
Agency Costs:

the costs resulting from managers misusing their position, as well as

the costs of monitoring and discipling them to prevent abuse.

Transaction Cost Economics

(TCE)

TCE views the firm as a governance structure (while the agency theory
views it as a nexus of contracts)

Firms grow to achieve economies of scale

by technological advances, or

by the fact that natural monopolies have evolved

How can
companies
raise capital?
From the capital market with
a wider shareholder base

In this case ..

Q: Whats the difference between TCE and the agency theory?

A: In TCE, transactions are undertaken internally rather than

externally

TCE and Agency Theory

Both theories are concerned with managerial discretion

Both assume that mangers are given to opportunism and moral
hazard

Both assume that managers operate under bounded rationality

Both regard the board of directors as an instrument of control

Bounded Rationality

From the previous slide we said: Both [theories] assume that

managers operate under bounded rationality. This means that
managers will tend to satisfice, or satisfy and suffice, rather than
maximize profit (not being in the best interest of shareholders)

Stakeholder Theory

In agency theory, maintenance or enhancement of shareholder value

is paramount
Here, in the stakeholder theory we take into account a wider group of
people:
shareholders, employees, providers of credit, customers, suppliers,
government, local community

Should we favor shareholders over other stakeholders?

Stakeholders or
shareholders?

Enlightened value maximization utilizes much of the structure of

stakeholder theory but accepts maximization of the long-run value if
the firm as criterion for making requisite trade-offs among its
stakeholders... and therefore solves problems that arrives from
multiple objectives that accompany traditional stakeholder theory
-Jensen, 2001

Stewardship Theory

Its an alternative approach to corporate governance, in the agency

theory (by Donaldson and Davis)
Stewardship theory stresses the beneficial consequences on
shareholder returns if facilitative authority structures which unify
command by having roles of CEO and chair held by the same
person. -Donaldson and Davis
So, stewardship theory does not put manager under control of
owners, it empowers managers to take autonomous executive action

General Comments on the

Theories

Always consider the legal system and capital market development

Also, consider the ownership structure

Some countries tend to give good protection for shareholder rights,

while other countries emphasize more on on the rights of certain
stakeholder groups

Important notes ..

Companies cannot operate in isolation without having regard to their

actions on different stakeholder groups.
Companies should be able to

Attract and retain equity investment

Be accountable to their shareholders

Give real consideration to the interest of the wider stakeholder

constituencies