The Theory & Practice of

Corporate Governance

What is a Corporate?
A corporation is an artificial being, invisible, intangible and existing only in
the contemplation of the law. Being the mere creation of the law, it
possesses only those properties which the charter of its creation confers
on it, either expressly or as incidental to its very existence. These acts
are supposedly best calculated to effect the object for which it was
created. Among the most important properties are immortality, and, if the
expression to be allowed, individuality; which a perpetual succession of
many persons are considered the same, and may act as a single
individual.
Chief Justice John Marshall
By a company is meant an association of many persons, who contribute
money or money's worth to a common stock and invest it in some trade
or business, and who share profit and loss (as the case may be) arising
there from. The common stocks so contributed is denoted in money and
is the capital of the company. The persons who contributed it, or to whom
it belongs, are members. The proportion of capital to which each member
is entitled is his share. Shares are always transferable, although the right
to transfer them is often more or less restricted.
Justice Lindlay
2

Characteristics of a Corporation

Incorporated Association
Artificial Legal Existence
Perpetual Existence
Common Seal
Extensive Membership
Separation of Management from Ownership
Limited Liability
Transferability of Shares
3

The Concept of Governance

Governance means the process of decisionmaking

and

decisions

are

the

process

implemented

by
(or

which
not

implement).

Theoretical Basis of Corporate

Governance
1. Agency Theory
2. Stewardship Theory
3. Stakeholder Theory
4. Sociological Theory
5

Agency Theory

Owners (shareholders) / Principals

Management / Agents
Agency Problem
Agency Cost
Agency Loss
Problems with The Agency Theory
Mechanisms to Reduce Agency Cost

1.
2.

Fair & Accurate Financial Disclosures

Efficient & Independent Board of Directors

Types of Directors
Board of Directors

Executive Directors

Non- Executive Directors

Independent Directors

Affiliated Directors
(Nominee Directors)7

Agency Theory
Problems with Agency Theory
1. Limited success
2. Complexities of Investor - board relationship
3. Shareholders should have correct and adequate
information to wield effective control
4. Shareholders rarely make clear their exact target
returns and yet delegate authority to meet the
target
5. Shareholders hardly have sanctions over
boards.
8

Stewardship Theory

Stewards whose motives are aligned with the objectives

of their principals.
A stewards behavior will not depart from the interests of
his / her organization.
Control can be potentially counter productive, because it
undermines the pro- organizational behavior of the
steward, by lowering his / her motivation.
Stewardship refers to the responsibility of the board to
oversee the conduct of the business and to supervise
management which is responsible for the day-to-day
conduct of the business. In addition, as stewards of the
business, the directors function as the catch-all to ensure
no issue affecting the business and affairs of the
9
company falls between cracks. Canadian Guidelines

Agency Theory Vs Stewardship Theory

A) Behavioral Differences
Agency Theory
Stewardship Theory

Manager acts as agents

Governance approach is
materialistic
Behavior pattern is individualistic,
opportunistic & self-serving
Managers are motivated by their
own objectives
Interests of the managers and
principals differ
The role of the management is to
monitor and control
Owners attitude is to avoid risks
Principal-Manager relationship is
based on control

Managers act as stewards

Governance approach is
sociological & psychological
Behavior pattern is collectivistic,
pro-organizational & trustworthy
Managers are motivated by the
principals objectives
Interests of the managers and
principals converge
The role of the management is to
facilitate and empower
Owners attitude is to take risks
Principal-Manager relationship is
based on trust
10

B) Psychological Mechanism
Agency Theory

Stewardship Theory

Motivation revolves around

Motivation revolves around

1.
2.

Lower order needs

Extrinsic needs

1.
2.

Higher order needs

Intrinsic needs

Social comparison is between

compatriots

Social comparison is between

principals

There is little attachment to the

company

There is great attachment to the

company

The power rests with the institution

The power rests with the personnel

11

C) Situational Mechanisms
Agency Theory

Stewardship Theory

Management philosophy is control

oriented

Management philosophy is
involvement oriented

To deal with increasing uncertainty &

risk, the theory advocates exercise of
Greater controls
More supervisions

To deal with increasing uncertainty

& risk, the theory advocates
exercise of
Greater training & empowering
people
Making jobs more challenging &
motivating

Risk orientation is done through a

system of control
Time frame is short term

Risk orientation is done through

trust

The objective is cost control

Time frame is long term

Cultural differences revolve around

Individualism
Large power distance

The objective is improving

performance
Cultural differences revolve around
collectivism
Small power distance
12

Stakeholder Theory
Stakeholders = Shareholder Group
+
Non-shareholder Group
Employees
Customers
Dealers
Government
Society at Large
13

Criticism of the Stakeholder Theory

Not applicable in practice by Corporation
Comparatively little empirical evidence
Difficulty of defining the concept
Leading to chaos
Opening doors to corruption
14

Shareholder vs Stakeholder
Approaches
Shareholder
Obeying the law
Maximizing shareholders wealth
Assumption Perfect Competition
Stakeholder
Board & Management have responsibilities to
parties other than shareholders.
Profit maximization subject to the constraint of
respecting obligations owed to such
stakeholders.
15

Sociological Theory

Power & Wealth Distribution

Board Composition
Financial Reporting
Disclosure
Auditing
Equity & Fairness

16

Why Corporate Governance?

Companies need to be governed as well
as managed
The board of directors is central and its
structure & processes are fundamental
The boards relationship with the
companys shareholders, regulators,
auditors, top management and other
legitimate stakeholders
17

Corporate Governance System

Board
Management

Interaction Between the Management And

the Board
18

Corporate Governance Systems

The Anglo-American Model Unitary Board Model
The German Model Two-Tier Model
The Japanese Model Business Network Model
The Subcontinent Model

19

The Anglo-American Model

Unitary Board Model (Anglo-Saxon)
Shareholders

Elect

Board of Directors
(Supervisors)

Stakeholders

Appoints &
supervises

Officers
(Managers)
Creditors

Lien on
Own

Manage Monitors
&
Regulates

Regulatory/
Legal system

Company
Stake in
20

The German Model

Two-Tier Board Model
Appoint 50%

Supervisory Board

Appoint 50%

Appoints &
Supervises

Employees &
Labor Unions

Management Board
(Including Labor
Relations Officer)

Shareholders

Manage

Company

Own

21

The Japanese Model Business Network Model

Appoint

Supervisory Board
(Including President)
Ratifies the
Presidents decisions

Shareholders

Provides Managers,
Monitors & Acts in
Emergences
Provides
Managers

President
Consults

Main Bank

Executive Management
(Primarily Board of Directors)
Manages
Provides Loans
Own

Company

Owns
22

Subcontinent Model of Governance

External Environment
Government Regulations, Policies,
Guidelines etc.

Corporate Culture, Structure

Characteristics, Influences

Internal Environment
Company Vision; Mission, Policies, Norms
Companys Act
SEC
Stock Exchanges

Auditors
Internal
Stakeholders

Proper Governance

CORPORATE
GOVERNANCE
SYSTEM

Board of
Directors

Depositors, Borrowers,
Customers and Other
Stakeholders

Shareholder Value

Corporate Governance Outcome / Benefits to Society

Transparency
Investor Protection

Concern for Customer

Healthy Corporate Sector Development
23

Why Good Governance?

24

Obligation To Society At Large

National Interest

Environment-Friendliness

Political Non-Alignment

Healthy & Safe Environment

Legal Compliances

Competition

Rule of Law

Trusteeship

Honest & Ethical Conduct

Corporate Citizenship

Accountability

Effectiveness & Efficiency

Ethical Behavior

Timely Response

Social Concern

Corporate Social Responsibility

Corporations Should Uphold The

Fair Name Of The Country

25

Obligation To Investors
Towards Shareholders
Measures Promoting Transparency &
Informed Shareholder Participation
Transparency
Financial Reporting & Records
26

Obligation To Employees

Fair Employment Practices

Equal Opportunities Employer
Encouraging Whistle Blowing
Humane Treatment
Participation
Empowerment
Equity & Inclusiveness
Participative & Collaborative Environment
27

Obligation To Customers
Quality Of Products & Services
Products At Affordable Prices
Unwavering Commitment To Customer
Satisfaction

28

Managerial Obligations

Protecting Companys Assets

Behavior Towards Government Agencies
Control
Consensus-Oriented
Gifts & Donations
Role & Responsibilities of Corporate Board &
Directors
Direction & Management Must Be Distinguished
Managing & Whole-Time Directors
29

Corporate Governance in the

Subcontinent
Problems
o Inadequate Sanction and Enforcement.
o No clear demarcation of control mechanisms between

SEC and Stock Exchanges.

o Lack of Professionalism of Directors
o Institutional Investors show poor commitment
o Boards are not professional
o Non-independent Independent directors
o Whistle Blower Policy not in place

o Too many unlisted companies

o Accounting gimmicks
o Poor Shareholder participation
o Obliging auditors
o Soft State, lethargic judiciary, inefficient market

regulator, poor enforcement machinery, and a value

system which is indifferent to moral wrongdoing.

However things are improving now

o

The market is competition driven

Professional new players are coming in

High growth in market capitalization

Well-focused, well-researched portfolio investors

Media influences

Influence of banks and financial institutions

Realization among the subcontinent companies of the benefits of

corporate governance and

Impending Capital Account Convertibility will exert its own pressure

(initiative by the World Bank & IMF)

Johnson & Johnsons excellent Credo exemplarily

epitomises what an ideal corporate should aspire to
be.
Our Credo
We believe our first responsibility is to the doctors, nurses and
patients,
to mothers and fathers and all others who use our products and
services.
In meeting their needs everything we do must be of high quality.
We must constantly strive to reduce our costs
in order to maintain reasonable prices.
Customers' orders must be serviced promptly and accurately.
Our suppliers and distributors must have an opportunity to make
a fair profit.

We are responsible to our employees,

the men and women who work with us throughout the world.
Everyone must be considered as an individual.
We must respect their dignity and recognize their merit.
They must have a sense of security in their jobs.
Compensation must be fair and adequate,
and working conditions clean, orderly and safe.
We must be mindful of ways to help our employees fulfill their family responsibilities.
Employees must feel free to make suggestions and complaints.
There must be equal opportunity for employment, development
and advancement for those qualified.
We must provide competent management,
and their actions must be just and ethical.