Corporate

Governance
Theories
Dr M Manjunath Shettigar
 Corporate Governance Theories

Evolution of Corporate Governance

Theories

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 Corporate Governance Theories

After Studying this chapter, you will be able to:

Understand the concept of corporation
Trace a brief history of corporations
Understand how modern corporations come
in to existence
Provide a brief outline of corporate
governance
Analyze the importance of CSR in governance

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 Corporate Governance Theories

Theories of Corporate Governance

Agency theory
Stewardship theory
Shareholders Vs stakeholders theory
Transaction cost theory
Sociological theory

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 Corporate Governance Theories

Theories of Corporate Governance (contd)

Agency theory
The economic relationship that arises
between two individuals
Principal
Agent
Three conditions to operate relationship
The agent has the freedom to choose
between various course of actions
Actions of agent influence their own
growth as well as the principals
Difficult for the principal to observe
the actions of the agent as
information is not enough
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Corporate Governance Theories

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 Corporate Governance Theories

Theories of Corporate Governance (contd)

Agency theory
The supplier of finance need return on
their investment
Principal needs assurance that agent does
not steal the investment
Principal needs to control the agent
Control is dispersed and less effective
Problems with agency theory
Utility maximizer (agent will not act in
the best interest of the principal
Unequal sharing of information
Element of risk (judge performance based
on annual reports )
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 Corporate Governance Theories

Theories of Corporate Governance (contd)

Agency theory
Agency loss
How to reduce it
Focuses on quantitative and not
qualitative aspect
To overcome the problems mentioned above:

Transparent accounting practices and

disclosure
Non executive independent directors

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 Corporate Governance Theories

Stewardship Theory
Built on premise that directors will fulfill their duties
towards the shareholders
Assumes that human are good and directors are trustworthy
Directors are stewards whose motives are aligned with the
objectives of the principles
Directors take in to account the stake holders but after the
shareholders
Strengths
Trust is high and stewards are motivated
New ideas and growth
More liberal and believes in empowerment
Weaknesses
Causal relationship between governance and
performance cannot be assessed using this theory

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 Corporate Governance Theories

Transaction Theory
Assumes that managers seek self interest
Managers operate under bounded rationality
Selfishly driven to undertake transaction
that benefits them personally
Make transaction without study as the money
invested is not their own
Strengths / weaknesses
Quantification is easy
Shareholders are residual receivers ,
concern about safety of investment

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 Corporate Governance Theories

The sociological theory

Composition of the board, transparency of
the financial reporting, disclosure and
auditing are considered central to realizing
the socio economic objectives
Strengths / weaknesses
Based on fair distribution of wealth in
society
The challenge is that the board should
not have absolute powers
Government control, interference may
increase leading to constraints and
red tape
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 Corporate Governance Theories
Importance of CSR in corporate governance
Stakeholders theory is integral to corporate
governance in addition to shareholders value
General acceptance that government cannot mange
all needs of society and companies have to involve
themselves for the welfare of stakeholders
Corporations have the following responsibility
Economic
Legal
Ethical
Honor trust
Be culture sensitive to provide the right
services
Discretionary
Undertake voluntary activities and
expenses, keeping the greater good of
society in mind
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