Specifics of Corporate Governance - Essay Example

?Corporate governance Corporate governance refers to a field that focuses on the association between boards, stockholders, top management, regulators, auditors and other stakeholders, and can also be defined as the relationship between various participants in determining the direction and performance of a corporation (Maassen, 2002, p. 12). The said stakeholders are similar to those of the first definition, as they include shareholders, management, and members of the board of directors, employees, customers, suppliers, creditors, and other interested parties. The definition given by the World Bank differs from the above two in that it includes the role of regulations and laws, as it defines corporate governance as a blend of law, regulation and appropriate voluntary, private sector practices enabling a corporation to attract financial and human capital, increase efficiency and fulfil its goals by generating long-term economic value for shareholders and respecting the interests of stakeholders and society (Maassen, 2002, p. 12). This paper seeks to compare and contrast the theoretical framework of corporate governance, and explain how agency theory can be used to explain corporate governance arrangements in modern companies. The agency theory emanates from the separation of control from ownership such that professional managers manage the firm on behalf of the original owners. The theory draws strength in the rise of conflicts when the owner of a firm perceives that professional managers do not follow the best interests of the owners (Wong and Mwanzia, 2011, p., 2011, p. 16). The theory focuses on analyzing and resolving relationship between owners and shareholders of a firm and the agents or top management, this is based on the basic assumption that the role of a firm is to maximize the wealth and investment of its owners and shareholders. The agency theory works based on a form operating with limited information and uncertainty in its operations. As a result, the firm remains exposed to possibilities of agency issues such as adverse selection and moral hazard. Adverse selection in this case occurs when principals fail to determine, with certainty, whether an agent accurately portrays his or her ability to execute the duties with which they are charged. On the other hand, moral hazard refers to a condition under which a principal cannot ascertain the probability of an agent putting or giving their best towards the wellbeing of a firm (Wong and Mwanzia, 2011, p. 16). The theory also purports that availing superior information on a firm to professional managers gives an edge to agents over the owners. This is because the top managers of a firm may bear more interest in individual welfare than that of the firm or its shareholders and owners. This way, managers fail to act maximally towards the returns of a firm unless proper governance structures are out in place as a means to safeguard the interest of shareholders (Wong and Mwanzia, 2011, p. 16). As a result, the agency theory calls for curtailing the potential of managers to behave in ways that contradict the best interests of shareholders and owners of any given firm. In addition, the theory brings to light the strength of top management in having the stock of a firm held in a wide manner by many shareholders, and the composition of the board of directors being that of people with little knowledge on the firm. According to this theory, the management should be in a position to own stocks of the firm they manage in order to create a positive relationship between corporate governance and the amount of stock owned by the top management (Wong and Mwanzia, 2011, p. 16). This way, the agency managing the form can put the interests of the firm ahead of their own, and the conflict between ownership and agency can end. Thus, because of having a substantial amount of stock in their name, top management becomes more willing to take responsibility for the decisions it makes concerning the firm. In addition of concern, is the issue of generating rules and incentives in a bid to align the conduct of managers to those of owners and shareholders, despite the impossibility f generating guidelines for every possible scenario (Aguilera and Jackson, 2002, p. 2). The use of incentives is meant to bring about risk sharing in the firm between shareholders and management thus motivating managers. In addition, it creates the need to shield managers from risk, thus the need to utilize low power incentives; in the form of performance related pay or shares. Overall, the theory portrays the self-centred nature and not the altruistic one where management cannot be trusted to act in the best interests of others. In this case, others are used to refer to shareholders, and the self-centred parties only seek to maximize their own utility at the expense of the said shareholders. As a result, the theory suggests that the actions, behaviour and conduct of directors and management, supposed to represent shareholders, should be looked into to protect the wellbeing of a firm and the interests of its shareholders (Wong and Mwanzia, 2011, p.17). Stewardship theory bears its rots from the psychological and sociological findings. It is defined based on the role of a steward in protecting, protection, and maximization of shareholders wealth through the firm performance (Abdullah and Valentine, 2009, p. 90). In this case, the steward represents the company executives and managers who work towards the interests of the shareholders or owners of a given firm, and are charged to protect and make profits for the said shareholders. This theory works in a manner wholly different from that of the agency. This is in that it focuses on the role of top management unlike its counterpart that looks at the individualism of top management and their potential untrustworthiness. As a result, it views top mangers as stewards who integrate their own goals to be part of those of the organization for which they work (Abdullah and Valentine, 2009, p. 90). Therefore, top management derives satisfaction and motivation from the success of the firm they represent. The theory is also opposed to that of the agency in that it, stewardship, observes the importance of structures empowering the stewards and maximizes their autonomy based on trust. This is unlike agency theory that perceives employees as economic beings, thus suppressing an individual’s own aspirations. Stewardship stresses on the position of employees and executives to act in an autonomous manner so that shareholders can reap maximum returns. In turn, stewardship cuts the costs that are used in monitoring and controlling the behaviour of executives and employees in the agency theory. The theory puts in place means for managers and employees to salvage or keep up their reputations as decision makers by working towards maximal financial performance. This way, the performance of a firm reflects n the individual performance of workers directly (Abdullah and Valentine, 2009, p., 2009, p. 90). The theory also looks into the issue of effectively cutting costs of operation by the unification of the posts of the chairperson and the chief executive officer (CEO). The said move also puts a greater role of a steward to the organization on the chairperson, thus a better chance of safeguarding the interests of shareholders than when devolved. The stakeholder theory differs from the other two theories in that it focuses on the needs of the stakeholders and not on a few individuals, the owners, or shareholders of a firm. The theory builds base on sociological and organizational disciplines combined. The theory incorporates philosophy, ethics, economics, political theories and organizational theories, as well as law. The theory refers to any party or individual that can be affected by the achievement of a firm’s objectives (Abdullah and Valentine, 2009, p. 91). It opposed to the other two theories in that managers are perceived as having a network of relationships to serve, unlike agency theory. In this regard, their goal is to pay attention to stakeholders who deserve their attention, this is in spite of the effect it has on decision making for managers; moreover, the theory also looks into the processes and outcomes of relationships to a firm and its stakeholders. This is to say that the overall wellbeing of a firm is paid attention to in the theory as the performance of a firm affects shareholders and their perception of the management. When this is put into perspective, the stewardship and stakeholder theories appear to hold a lot of similarity in functionality. This is because, they both look into the role of managers and how they can better look after the firm while factoring in interests of all parties. In addition, just like a firm bears responsibility to its investors, other parties that contribute to its success or failure should be focused on (Heath and Norman, 2004, p. 3). In this theory, it does not seek to protect shareholders as a special party in a firm. This is because; shareholders are just one part of the stakeholders in an organization and the role of managers in the organization is defined. Managers play the role of meeting the legal obligation of a form to other stakeholders such as suppliers and meet social responsibilities. Hence, all theories brought together have differences in what they stand for and their common grounds in interests and focus. This is as seen in the agency theory that differs in almost every aspect on the role and lack of trust by shareholders towards managers with stewardship theory. In the stakeholder theory, the two theories, agency, and stewardship theory seem to agree on the wellbeing and the shortcomings of each theory. Overall, there is not one theory that can stand on its own and argue out its suitability unless combined with another this is in order to appropriately focus on the interests of all parties. Thus, the agency theory in modern companies explains only the common practice of management because shareholders tend to put measures in place, in the form of curtailing the capabilities of managers. As a result, it can only be applied in looking at the welfare of the shareholders due to trust issues, in this way, shareholders are assured of their profits, but the company cannot function appropriately. Therefore, selective application of the agency theory should be practiced with a blend of other theories for the overall wellbeing. Thus, it cannot be used, in exclusion of the other theories, to explain corporate governance arrangements in modern companies. References Abdullah, H. and Valentine, B. (2009) Fundamental ethics Theories of Corporate Governance. Middle Eastern Finance and Economics Issue 4. Aguilera, R. and Jackson, G. (2002) Hybridization and Heterogeneity Across National Models of Corporate Governance. Economic Sociology 3 (2): 17-26 Maassen, G. (2002). An international Comparison of Corporate Governance Models. [WWW] Available from http://repub.eur.nl/res/pub/8028/Maassen_9789090125916.pdf. [Accessed 25/08/2012]. Wong, P, and Mwanzia, B. (2011) Corporate Governance Practices in Developing Countries: The Case for Kenya. International Journal of Business Administration Vol. 2, No. 1. Heath, J. and Norman, W. (2004) Stakeholder Theory, Corporate Governance and Public Management. Journal of Business Ethics 53, pp 247-265. Read More