Transcript 002 Theoretical Aspects of Corporate Governance

MGT 427 - Corporate Governance
Theoretical Aspects of
Corporate Governance
Faisal AlSager
September 17, 2011
Objectives
✤
To understand the various main theories that underline the
development of corporate governance
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To be aware of the impact of the form of legal system, capital market,
and ownership structure on the development of corporate governance
No Single Universal Theory
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Development of corporate governance is
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a global occurrence, and
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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
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There are 4 main theories that have affected the development of
corporate governance:
✤
Agency Theory
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Transaction Cost Economics
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Stakeholder Theory
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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):
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Mangers (agents)
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Owners (principles)
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Managers must be monitored and institutional arrangements must provide
some checks and balances to make sure they don’t 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: What’s 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
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Both assume that mangers are given to opportunism and moral
hazard
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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?
Corporate Governance
Anglo-American Model
✤
Emphasis on shareholder value
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Board totally comprised of executive and
non-executive directors elected by
shareholders
Corporate Governance
German Model
✤
Certain stakeholder groups, like
employees, have a right enshrined in law
for their representatives to sit on the
supervisory board alongside the directors
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
✤
✤
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It’s 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
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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 ..
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Companies cannot operate in isolation without having regard to their
actions on different stakeholder groups.
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Companies should be able to
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Attract and retain equity investment
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Be accountable to their shareholders
✤
Give real consideration to the interest of the wider stakeholder
constituencies
References
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Corporate Governance: Mallin, Tina. Oxford.