Corporate Governance

Qst.)Write an essay on key theories that are widely discussed in the academic literature on corporate governance. Critically analyse the strengths and weaknesses of each theories. In your essay, you are expected to compare and contrast these theories and state which theory, in your opinion; best explains the governance mechanisms of listed companies in the UK.

Introduction:-

Corporate governance act as a forum for the exchange of information, insights and knowledge based on both theoretical development and practical experience. Corporate governance is defined broadly as the exercise of power and responsibility for corporate entities. There is no single, accepted definition of corporate governance. The majority of definition employed by corporate practitioners relates corporate governance to control of the company. Cadbury report defined corporate governance as "Corporate governance is system by which business are directed and run". "Corporate governance is a framework of legal, institutional, and cultural factors shaping the patterns of influence that stakeholders exert on managerial decision-making (Weimer and Pape ,1999)". But one which is given by the Parkinson in 1994 is strongly agreed by the masses, according to them "Corporate governance is the process of supervision and control intended to ensure that company's management acts in accordance with the interest of the shareholder" (Solomon 2003).

Corporate governance has been the most common phrase used in current global business vocabulary. It is a multi-faceted subject, it deals with the issue of accountability and fiduciary duty, laws and policies of companies, and it mainly ensures the guidelines and mechanism behaviour towards the shareholder & economic behaviour. There are yet another important aspect to the corporate governance behaviour as a stakeholder view, such as environmental concern, employee welfare, creditor and society as whole etc. The corporate governance structure specifies the rules and procedure for making decisions on corporate affairs. It also provide structure through which companies objectives are set, as well as means of attaining and monitoring of these objectives. Collapse of Enron in 2001 which is one of the largest company of America, has focused international attention on company failure and role that strong corporate governance needs to play to prevent them. Higgs report(2003) and Smith report(2003)produced by the UK government in responding to this failure. While America produced the Sarbanes-Oxley Act(2002).

There are number of different theories to explain and analyse corporate governance from different views, such as Stewardship theory that provides better explanation of government effectiveness in specific circumstances while, agency theory arises from finance and economic perspective, and stakeholder theory arise from more social-oriented perspective on corporate governance. They are marked with differences between the various theoretical framework, as they each trying to analyse the same problem from different view.

Stewardship theory : - Stewardship theory has been introduced as a means of defining relationships based upon other behavioural premises (Donaldson & Davis,1991). This theory treated directors as stewards of the company. They don't work for personal goal or profit but rather are stewards whose motive is progress of the company. These include the need of successful performance, respect for authority and the work ethic and reputation (Daily, Dalton and canella, 2003).

Stewardship theory assumes that the principal and the steward can cooperate with each other and achieve a "goal alignment" (Davis et al., 1997).This theory assumes that manager can work better in environment where they trusted and granted decision making power." The optimal governance structure is one that authorizes managers to act and allows board-management coordination to be achieved most effectively (Donaldson, 1990)".Although this theory suggests that manager as a stewards and work for the benefit of the company but, in practice, it is a rare phenomena and this we can say from the increase in the number of the collapse of the company. In most of the cases director misleading information to shareholder e.g. Enron 2001.

Agency theory : - Agency theory argues that in the modern corporation, in which share ownership is widely held, managerial actions depart from those required to maximise shareholder returns (Pratt and Zeckhauser 1985). Agency theory theoretical exposition defined by Jensen and Mecling(1976 )according to them manger will not act to maximise return to shareholder unless appropriate governance structure are implemented in the large corporation of safeguard shareholders interest. In agency theory terms shareholders are the principal of the firm and managers who runs the company its called agent"Agency theory specifies mechanisms which reduce agency loss (Eisenhardt