introduction

Corporate governance is an important factor in managing corporation in the current global and multifarious environment. Therefore, this chapter presents a review of literature on corporate governance. While review literature on corporate governance this proposed study will embark on delineation of the fundamental theories of corporate governance as part of theoretical framework. In addition, the proposed study will analyse the effectiveness of a set of external and internal disciplining mechanisms in providing a solution for the corporate governance problem.

theoretical literature

In this section we will mainly concentrate on fundamental theories of corporate governance. Fundamental theories include

Agency Theory

Agency theory having its roots in economic theory was exposited by Frydman in 2009. Agency theory is defined as “the relationship between the principals, such as shareholders and agents such as the company executives and managers”. According to this theory, shareholders are defined as the owners or principals of the company; they hire the agents to espouse their interests. Principals delegate the running operations of business to the directors or managers, who are the shareholder’s agents. Indeed, Frydman (2009) argued that two factors can influence the prominence of agency theory. First, the theory is conceptually and simple theory that reduces the corporation to two participants of managers and shareholders. Second, agency theory suggests that employees or managers in organizations can be self-interested.

The agency theory shareholders expect the agents to act and make decisions in the principal’s interest such that they increase the value of the firm. On the contrary, the agent may not necessarily make decisions in the best interests of the principals. Such a problem was first highlighted by Adam Smith in the 18th century and a detailed description of agency theory was presented by Frydman in 2009.

In agency theory, the agent may be succumbed to self-interest, opportunistic behavior and falling short of congruence between the aspirations of the principal and the agent’s pursuits. Even the understanding of risk defers in its approach. Although with such setbacks, agency theory was introduced basically as a separation of ownership and control (Aras, 2009). Aras (2009) argued that instead of providing fluctuating incentive payments, the agents will only focus on projects that have a high return and have a fixed wage without any incentive component. Although this will provide a fair assessment, but it does not eradicate or even minimize corporate misconduct. Here, the positivist approach is used where the agents are controlled by principal-made rules, with the aim of maximizing shareholders value. Hence, a more individualistic view is applied in this theory. Indeed, agency theory can be employed to explore the relationship between the ownership and management structure. However, where there is a separation, the agency model can be applied to align the goals of the management with that of the owners. Due to the fact that in a family firm, the management comprises of family members, hence the agency cost would be minimal as any firm’s performance does not really affect the firm performance (Calder, 2009). The model of an employee portrayed in the agency theory is more of a self-interested, individualistic and are bounded rationality where rewards and punishments seem to take priority .This theory prescribes that people or employees are held accountable in their tasks and responsibilities.

Employees must constitute a good governance structure rather than just providing the need of shareholders, which maybe challenging the governance structure.

Stewardship Theory

Stewardship theory has its roots from psychology and sociology and is defined by Colley (2010) as a tool of protecting shareholders and maximizing their wealth, as a result. In this perspective, stewards are company executives and managers working for the shareholders, protects and make profits for the shareholders. Unlike agency theory, stewardship theory stresses not on the perspective of individualism (Colley, 2010), but rather on the role of top management being as stewards, integrating their goals as part of the organization. The stewardship perspective suggests that stewards are satisfied and motivated when organizational success is attained.

Colley (2010) argues agency theory looks at an employee or people as an economic being, which suppresses an individual’s own aspirations. However, stewardship theory recognizes the importance of structures that empower the steward and offers maximum autonomy built on trust. It stresses on the position of employees or executives to act more autonomously so that the shareholders’ returns are maximized. Indeed, this can minimize the costs aimed at monitoring and controlling behaviors.

On the other end, Crowther (2011) argued that in order to protect their reputations as decision makers in organizations, executives and directors are inclined to operate the firm to maximize financial performance as well as shareholders’ profits. In this sense, it is believed that the firm’s performance can directly impact perceptions of their individual performance Stewardship model can have linking or resemblance in countries like Japan, where the Japanese worker assumes the role of stewards and takes ownership of their jobs and work at them diligently.

Moreover, stewardship theory suggests unifying the role of the CEO and the chairman so as to reduce agency costs and to have greater role as stewards in the organization. It was evident that there would be better safeguarding of the interest of the shareholders. It was empirically found that the returns have improved by having both these theories combined rather than separated

Stakeholder Theory

Stakeholder theory was embedded in the management discipline in 1970 and gradually developed by Freeman incorporating corporate accountability to a broad range of stakeholders. Effross (2009) argued that stakeholder theory derived from a combination of the sociological and organizational disciplines. Indeed, stakeholder theory is less of a formal unified theory and more of a broad research tradition, incorporating philosophy, ethics, political theory, economics, law and organizational science.

Stakeholder theory can be defined as a group of individuals that have the potential of affecting organization’s objectives or can be affected by the objectives. Unlike agency theory in which the managers are working and serving for the stakeholders, stakeholder theorists suggest that managers in organizations have a network of relationships to serve – this include the suppliers, employees and business partners. Freeman 1999 argued that this group of network is important other than owner-manager-employee relationship as in agency theory. On the other end, Fernando (2010) contends that stakeholder theory attempts to address the group of stakeholder deserving and requiring management’s attention. Freeman in his early days contended that the network of relationships with many groups can affect decision making processes as stakeholder theory is concerned with the nature of these relationships in terms of both processes and outcomes for the firm and its stakeholders. Fernando argued that this theory focuses on managerial decision making and interests of all stakeholders have intrinsic value, and no sets of interests is assumed to dominate the others.

Resource Dependency Theory

Whilst, the stakeholder theory focuses on relationships with many groups for individual benefits, resource dependency theory concentrates on the role of board directors in providing access to resources needed by the firm. Joshi (2011) postulates that resource dependency theory focuses on the role that the directors play in providing or securing essential resources to an organization through their linkages to the external environment. Indeed, Keasey (2008) concurs that resource dependency theorists provide focus on the appointment of representatives of independent organizations as a means for gaining access in resources critical to firm success. For example, outside directors who are partners to a law firm provide legal advice, either in board meetings or in private communication with the firm executives that may otherwise be more costly for the firm to secure.

It has been argued that the provision of resources enhances organizational functioning, firm’s performance and its survival. According to Joshi (2011) directors bring resources to the firm, such as information, skills, access to key constituents such as suppliers, buyers, public policy makers, social groups as well as legitimacy. Directors can be classified into four categories of insiders, business experts, support specialists and community influential’s. First, the insiders are current and former executives of the firm and they provide expertise in specific areas such as finance and law on the firm itself as well as general strategy and direction. Second, the business experts are current, former senior executives and directors of other large for-profit firms and they provide expertise on business strategy, decision making and problem solving. Third, the support specialists are the lawyers, bankers, insurance company representatives and public relations experts and these specialists provide support in their individual specialized field. Finally, the community influentials are the political leaders, university faculty, members of clergy, leaders of social or Community organizations.

Transaction Cost Theory

            Transaction cost theory was first initiated by Cyert. Later on, Macey (2011) described the theory in theoretical perspectives. Transaction cost theory was an interdisciplinary alliance of law, economics and organizations. This theory attempts to view the firm as an organization comprising people with different views and objectives. The underlying assumption of transaction theory is that firms have become so large they in effect substitute for the market in determining the allocation of resources. In other words, the organization and structure of a firm can determine price and production.

The unit of analysis in transaction cost theory is the transaction. Therefore, the combination of people with transaction suggests that transaction cost theory managers are opportunists and arrange firms’transactions to their interests.

Political Theory

            Political theory brings the approach of developing voting support from shareholders, rather by purchasing voting power. Minow (2011) asserts that having a political influence in corporate governance may direct corporate governance within the organization. Public interest is much reserved as the government participates in corporate decision making, taking into consideration cultural challenges. The political model highlights the allocation of corporate power, profits and privileges are determined via the governments’ favor. The political model of corporate governance can have an immense influence on governance developments. Over the last decades, the government of a country has been seen to have a strong political influence on firms. As a result, there is an entrance of politics into the governance structure or firms’ mechanism.

Ethics Theories and Corporate Governace

Other than the fundamental corporate governance theories of agency theory, stewardship theory, stakeholder theory, resource dependency theory, transaction cost theory and political theory, there are other ethical theories that can be closely associated to corporate governance. These include business ethics theory, virtue ethics theory, feminist ethics theory, discourse ethics theory, postmodern ethics theory.

Business ethics is a study of business activities, decisions and situations where the right and wrongs are addressed. Solomon (2012) postulates that the main reasons for this are the power and influence of business in any given society is stronger than ever before. Businesses have become a major provider to the society, in terms of jobs, products and services. Business collapse has a greater impact on society than ever before and the demands placed by the firm’s stakeholders are more complex and challenging. Only a handful of business giants have had any formal education on business ethics but there seems to be more compromises these days. Business ethics helps us to identify benefits and problems associated with ethical issues within the firm and business ethics is important as it gives us a new light into present and traditional view of ethics.

Ethics is defined as the study of morality and the application of reason which sheds light on rules and principle, which is called ethical theories that ascertains the right and wrong for a situation.

Whilst business ethics theory focuses on the “rights and wrongs’ in business, feminist ethics theory emphasizes on empathy, healthy social relationship, loving care for each other and the avoidance of harm. In an organization, to care for one another is a social concern and not merely a profit centered motive. Ethics has also to be seen in the light of the environment in which it is exercised. This is important as an organization is a network of actions, hence influencing transcommunal levels and interactions (Solomon, 2012).

Thompson (2010) outlined that Virtue ethics theory focuses on moral excellence, goodness, chastity and good character. According to him, virtue is a state to act in a given situation. It is not a habit as a habit can be mindless. For example, if a board member decides to be honest, now that a decision which he makes and thus strengthens his virtue of honesty. Virtue involves two aspects, the affective and intellectual. The concept of affective in virtue theory suggests “doing the right thing and have positive feelings”, whilst, the concept of intellectual suggests “to do virtuous act with the right reason”. Virtues can be instilled with education. Aristotle mentions that knowledge on ethics is just like becoming a builder. Through the process of educating and exposure to good virtues, the development of ethical values in a child’s life is evident. Hence, if a person is exposed to good or positive ethical standards, exhibiting honesty, just and fairness, than he would exercise the same and it will be embedded in his will to do the right thing at any given situation. Virtue ethics is eminent to bring about the intangibles into an organization. Virtue ethics highlights the virtuous character towards developing a morally positive behavior Virtues are a set of traits that helps a person to lead a good life. Virtues are exhibited in a person’s life.

 

empirical literature

To commence the review Wright (2008) reviewed the issues and challenges of corporate governance in Africa. He presented the reason for their review that many of the non financial corporations failed in the United States and in Asia due to the non efficient corporate governance. He said that Africa can learn a great from the experiences of these countries and may improve the governance for its corporate sector.

Wright (2008) conducted the review by studying a contribution on the corporate governance in Africa and said that the modern concepts of separation of management from the ownership make the corporate governance an important issue for research. The interests of people who control the organizations are differing from those who invest in the company by external finance. Also the principal agent problem and the interest of shareholders can only reduced through the effective corporate governance.

His study reviewed that the organization systems, practices, process and rules of governing institutions are concerned closely with the corporate governance so there is a need to find those relationships that regulate, create or determine the nature of relationship through those relationships. Corporate governance implies that companies should balance between the interests of shareholders with stakeholders at all levels of organization. Africa is highly influence by mismanagement, corruption in business environment, therefore effective corporate governance can create the transparency and safeguard against these threats facing by the companies to promote the foreign investment by foreign traders and companies (Solomon, 2012). The authors stated that research publication in the area of corporate governance is very low and suggested that the research should be promoted in both empirical and theoretical ways.

Yocam (2012) conducted the theoretical and empirical literature review to find out the true nature and consequences of corporate governance. The main focus of his literature was to find out the reasons of conflict between manager and shareholders in organizations with respect to ownership mechanism. He also tried to find out the link between the corporate governance and the value of the firm. He argued that major problem in organization arises with the relationship of principal and agent relationships and a different approach of manager than the shareholders. The perspective of the manager remains with the limited cash-flows thus managers focus lies with the short term perspective on investment whereas shareholders stuck with the quick return of cash flows. Risk preference is also a major source of conflict between the principal and the agent. Shareholders associated with the market risk and the risk of stock returns whereas managers always concerned with the company risk because their survival depends on the firm risk. The area of corporate governance is lacking with the external disciplining devices. The firms through the effective corporate governance can implement these devices which includes the composition of the board of directors, increase number of shareholders, maximize the inside ownership and by providing different financial policies and compensation packages.

Macey (2011) studied the Corporate Governance and Performance in Publicly Listed, Family-controlled Firms in Taiwan. He analyzed the effects of the structure of ownership and board characteristics on performance in large, publicly traded firms which are controlled by family. The author argued that firms located in East Asia, operate with a distinctive culture and in different legal and institutional environments than west and

Europe, these culture differences may have a strong impact on governance-performance relationships suggested by the study of agency and strategy research. The author did not find a direct association between family ownership and managerial entrenchment and extraction of the private benefits of this control, which might be the negative cause to financial performance. The author also identified the differences in corporate governance effects which are associated with different types of institutional shareholders. Macey suggested that foreign investors may be attracted to the Taiwan markets by the process of globalization which may lead to good corporate governance being imported by the domestic firms in Taiwan. The results of their study also find that family control over the executive board is the major determinant to the performance.

Minow (2011) studied the corporate governance of bank mergers and acquisitions. He was of a view that during these mergers and acquisitions the CEOs negotiates for their own interests whereas the outside directors of the company face the financial problems. The corporate governance of independent companies affected a lot. He made empirical investigation to find out the effects of personal benefits and the merger premiums by taking a sample of 146 mergers of large US banks in 1990s. The target was the two thousand directors and executives during these mergers and found that target’s merger premium is inversely related to the number of target directors who are retained during these mergers. This also implies for the corporation size, incentives, payment methods and bidder returns. The study found that the interests of target director relatively lies with the size of the company rather than performance and they exercise their bargaining power with the acquirer which counters the interests of shareholders’ interest in the merger.

Frydman (2009) studied the impact of internal corporate governance system on firms innovative activities and addressed the question that how much firms internal corporate governance system varieties with the type and efficiency of firm’s innovative activities. He listed out major participative actors for the firms which are the board, the shareholders, the managers and the other stakeholders for the companies. He defined the institutions as the rules and procedures use to make decisions on corporate affairs of the firm. Frydman (2009) designed his research on the definition of OECD which defines corporate governance in a narrow term as a relationship between a company and its shareholder whereas in broader term the relationship between the company and the society.

 Hypothesis

The role of corporate governance in an economy cannot be gainsaid. Yet the ongoing research and debate on ideal corporate governance structure appears to have paid inordinate attention to the role of board to the exclusion of other equally important aspects of governance such as ownership structure. In this study the conceptual framework will be based on the process of corporate governance the independent variable as illustrated in the diagram below.

 

 

 

 

 

 

 

                                                           

                                               

 

 

 

 

 

 

 

In order to achieve the objective of the study, the proposed study will aim at investigating whether the variable contribute towards better practices of corporate governance. In the above frame work, the institutional framework which forms the basis of argument; constituent laws and regulatory that are designed and formulate by the capital market authority.

To offer useful answers to the research questions and realize the study objectives, the following hypotheses stated in their null forms were tested.

The null hypothesis of the study will be as follows.

1. a) H0:There is no relation between good corporate governance and investor’s confidence
2. b) H0: there is no relation between the law and regulations formulated and enforced by capital market governance and good corporate governance practices.
3. c) H0:There is no relation between good corporate governance and the firms performance

conclusion

Although the input of renowned scholars in the development of corporate governance literature cannot be undermined, the literature by the scholars fails to recognize the various important factors in effective implement of corporate governance. First the scholars have failed to consider the external drivers of good corporate governance which include  laws, rules and institutions that provide a competitive playing field and discipline the behavior of insiders, whether managers or shareholders. They studies in the past have concentrated on the effectives and benefits of corporate governance while undermining  to study the role authorities charged with the responsibility of enforcing good corporate governance. The proposed study will bridge these gaps while adding up to the little literature on corporate governance.

 

Work Cited

Frydman, C.. “Key Findings and Main Messages.” Corporate Governance and the Financial       Crisis 5.7 (2009): 79. Print.

Aras, Guler . “Corporate Governance Documents.” Investor Information 7.2 (2009): 13. Print.

Calder, Alan . “A Guide for Fund Managers and Corporations.” Corporate Governance 12.6        (2009): 127. Print.

Colley, ohn . “Recomendations and Amendments.” Corporate Governance Principles 23.7           (2010): 27. Print.

Crowther, David . “Corporate Governance Overview.” Investments 5.9 (2011): 31. Print.

Effross, Walter . “The Foundation for Sustainable Business.” Corporate Governance 21.34           (2009): 11. Print.

Fernando, A . “German Corporate Governance Code.” Government Commission 2.4 (2010): 16.   Print.

Joshi , M. “Corporate Governance Report 2011.” Corporate Governance 7.3 (2011): 67. Print.

Keasey, Kevin . “Reality and Policies Mechanised.” Corporate Governance in India 21.2 (2008): 75. Print.

Macey, Jonathan R. . “Company Shareholder Dialogue.” Organizational Communication 3.5         (2011): 16. Print.

Minow, Nell . “Managing Diversity.” Principles of Corporate Governance 2.3 (2011): 67. Print.

Solomon , Jill . “Social Responsibility.” Voluntary Adoption 6.7 (2012): 23. Print.

Thompson, Steve . “Principles for enhancing corporate governance.” Banking supervision 12.13    (2010): 33. Print.

Wright, Michael . “Principles of Corporate Governance.” Management 9.5 (2008): 47. Print.

Yocam, Eric . “statement on corporate governance.” Financial Sercives 4.11 (2012): 113. Print.

 

 

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