CORPORATE GOVERNANCE

Module 5

Introduction to Corporate Governance Definition and attributes

of good corporate governance,
Corporate governance theories – Agency, Stewardship,
Shareholder, stake holder theory,
Role of Board of Governors,
Factors influencing quality of Corporate Governance
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The World Bank defines corporate governance as the relations among the owners,
the management board and other stakeholders.

According to the Organisation for Economic Co-operation and Development

(OECD), corporate governance specifies the distribution of rights and
responsibilities among different participants in the company and spells out the
rules and procedures for making and monitoring decisions on corporate
affairs.

In simple terms, Corporate governance refers to the rules, processes or laws

by which businesses are operated, regulated and controlled.

Good governance is not simply about corporate excellence. It is the key to

economic and social transformation. The corporation of today is no longer
sheer economic entities. These are the engines of economic and social
transformation.
 As per some important highlights of the OECD principles, the
corporate governance framework should:
1. Promote transparent and efficient markets, be consistent with the rule of law
and clearly articulate the division of responsibilities among different
supervisory, regulatory and enforcement authorities.

2. Protect and facilitate the exercise of shareholders‟ rights.

3. Ensure the equitable treatment of all shareholders.

4. Recognize the rights of stakeholders established by law or through mutual

agreements and encourage active co-operation between corporations and
stakeholders in creating wealth, jobs, and the sustainability of financially
sound enterprises.
5. Ensure that timely and accurate disclosure is made on all material matters
regarding the corporation, including the financial situation, performance,
ownership, and governance of the company.

6. Ensure the strategic guidance of the company, the effective monitoring of

management by the board, and the board‟s accountability to the
company and the shareholders.
Role of Corporate Governance
 Today‘ s corporate governance places a strong emphasis on both, economic
efficiency and safeguarding the welfare of shareholders.
 Presence of an effective corporate governance system, within a company and
across an economy as a whole, helps to strengthen the economy, create
investor confidence, and contribute to social wellbeing.
 Set right objectives;
 Chart the right processes of operations and process of governance;
 Ensure ethics in the corporate objectives and practice;
 Develop right kind of people and talent in the organisation;
 Inculcate the culture of ethics amongst people;
 Obey the rules, laws and regulations concerning the business;
 Adopt methods of measures and means to control and regulate within the rules
and regulations;
 Adhere to the environmental laws and regulatory principles.
 OBJECTIVES OF
CORPORATE GOVERNANCE
 GOOD GOVERNANCE THEORIES
AGENCY THEORY:

Agency theory (Jensen, Meckling, 1976) examines the relationship between the
agents and principals in the business. In an agency relationship, two parties exist
– the agent and principal, whereby the former acts and takes decisions on behalf
of the latter.

In corporate governance, agency theory relates to a specific type of agency

relationship that exists between the shareholders and directors/management of a
company. The shareholders, true owners of the corporation, as principals, elect the
executives to act and take decisions on their behalf. The aim is to represent the views
of the owners and conduct operations in their interest. Despite this clear rationale of
electing the board of directors, there are a lot of instances when complicated issues
come up and the executives, knowingly or unknowingly, take decisions that do not
reflect shareholders‟ best interest.

Agency theory presents directors/managers as opportunistic by seizing its optimum

advantage for his appointment and role as the mover in the firm for its own
benefit, at the expense of the principal.
Stewardship Theory:

Stewardship theory presents a model of management, where managers are

considered good stewards who will act in the best interest of the owners
(Donaldson & Davis, 1988). The fundamentals of stewardship theory are based on
social psychology, which focuses on the behaviour of executives. Theory asserts
that left on their own, managers will act as responsible stewards of the assets they
control.

The stewards are satisfied and motivated when organizational success is attained.
It stresses on the position of managers/executives to act more autonomously so
that the shareholders' returns are maximized. The focus of stewardship theory is
on structures that facilitate and empower rather than monitor and control.

Given a choice between self serving behaviour and pro-organisation behaviour,

a steward‘s behaviour will not depart from the interest from the interest of his/her
organisation.
Shareholders are always stakeholders in a corporation, but stakeholders might
not be shareholders.

Shareholder Theory:

Shareholders theory was introduced by Milton Friedman in 1960s. The shareholder theory is
based on the interests of the shareholders which is to achieve maximize shareholder value as
a goal. It states that sole responsibility of business is to increase profits.
The idea of the shareholder theory is that managers primarily have a duty to
maximize shareholders‘ interests in the way that is still permitted by law or social
values.

Shareholders approve the salary of a corporation‟s business managers, who, in

turn, are in charge of the corporation‟s spending, which should also be in line with the wishes of
the shareholders.

The role of shareholder theory can be seen in the demise of corporations such as Enron and
Satyam where continuous pressure on managers to increase returns to shareholders led them
to manipulate the company accounts.
Stakeholder Theory:

Stakeholder theory, states that a company owes a responsibility to a wider group

of stakeholders, other than just shareholders. A stakeholder is defined as any
person/group which can affect/be affected by the actions of a business. It includes
employees, customers, suppliers, creditors and even the wider community and
competitors.

Edward Freeman, the original proposer of the stakeholder theory, recognised it as

an important element of Corporate Social Responsibility (CSR), a concept which
recognises the responsibilities of corporations in the world today, whether they be
economic, legal, ethical or even philanthropic. Nowadays, some of the world‟s
largest corporations claim to have CSR at the centre of their corporate strategy.

Stakeholder theory has become more prominent because many researchers have
recognized that the activities of a corporate entity impact on the external
environment requiring accountability of the organization to a wider audience than
simply its shareholders.
Role of Board of Governors in Ensuring Ethical Business
The separation of ownership from active direction and management is an
essential feature of the company form of organization. To manage the affairs of
the company, shareholders elect their representatives called the “Directors” of the
company. A number of such directors constitute the “Board of Directors”.

The Company's business is managed under the direction of the Board of

Governors. The Board's role is to oversee the management and governance of the
Company and to monitor senior management's performance

Legal Position of a Director

•They have been described variously as agents, trustees, or managing partners of
the company.

• The legal position of the directors as agents and trustees emanate from the fact
that a company being an artificial person cannot act in its own person.

•It has become a well-settled fact now that directors are not only agents but also
act as trustees as a result of several court decisions in India..
Qualifications of Directors

No body corporate, association or firm can be

appointed directors of a company. A director
must:
(a) be an individual;
(b) be competent to enter into a contract; and
(c) hold a share qualification if so required by
the Articles of Association*.
Powers of the Board
The Board of Directors of a company which includes all
the directors elected by shareholders to represent their
interests is vested with the powers of management which
are:

(a)Make calls on shareholders in respect of money unpaid

on their shares;
(b)Issue debentures;
(c)Borrow moneys otherwise (for example, through
public deposits);
(d)Invest the funds of the company; and
(e)Make loans.
The Board of Directors of a company which
includes all the directors elected by shareholders
to represent their interests is vested with the
powers of management which are:

(a)Make calls on shareholders in respect of money

unpaid on their shares;
(b)Issue debentures;
(c)Borrow moneys otherwise (for example,
through public deposits);
(d)Invest the funds of the company; and
(e)Make loans.
Articles of association form a document that
specifies the regulations for a company's
operations and defines the company's purpose.
The document lays out how tasks are to be
accomplished within the organization, including
the process for appointing directors and the
handling of financial records.
 RESPONSIBILITIES OF DIRECTORS
1. An efficient and independent board should be conscious of
protecting the interests of all stakeholders and not be
concerned too much with the current price of the stock.

2. Another important function of the director is to set priorities

and to ensure that these are acted upon.

3. A director is also expected to have the courage of conviction

to disagree.

4. Directors have great responsibility in the matter of employment

and dismissal of the CEO.

5. One of the toughest challenges confronted by boards arises

while approving acquisitions.
6.An efficient board should be able to anticipate business events
that would spell success or lead to disaster if proper measures
are not adopted in time.

7.The directors have a duty to act bona fide for the benefit of the
company as a whole.
 Factors influencing quality of Corporate Governance
• Vision, values and goals -If corporate governance has to set the rules for
inclusiveness and sustained growth of a business, the leaders of the organisation
have to define (or derive) the vision, values and goals of the business; not
short-term but in the long-term sense.

• Value to the Society - Corporate governance is about creating a seamless

interface between the ethical practices of processes, people and policy in the
organisation for the „creation of value to the company and wellbeing to the
society‟.

• Greed of company executives - The system must also be able to effectively

check the greed of company executives and prevent them from the temptation
of earning a quick buck through unethical activities that are also not relevant to
value creation for the company and society.
• Integration of ethical principles- There is a need to integrate ethical
principles into the administrative and accountability structure of the corporate
governance system.
 References

Mandal, S.K. (2012), Business Ethics

and Corporate Governance, McGraw
Hills Publications, New Delhi. India.