Explore the theories of corporate governance, including agency theory, stewardship theory, stakeholder theory, and more, to understand how companies are directed and controlled.
A company is a legal entity or group of people coming together to do business and earn profit. There is always a need of investments and funds in the Company, so the owner decreases it shareholding to raise funds and involve the general public. The Company which flourishes generally appoints a CEO of the Company to manage the affairs of the Company.
The owner’s main aim is to make profit, and the manager aims to get a fixed salary out of business. This arrangement creates a widening gap between the objective and vision of the owner and manager, and the need for corporate governance arises. The need for corporate governance kicks in when the Company starts to flourish.
Corporate governance determines how the companies are directed and controlled. It is based on the FAT principle of Fairness, Accountability, and Transparency. It refers to action taken by the organization to improve the relationship and interaction with stakeholders, that is, Investors, board of directors, shareholders, general public, regulatory bodies, Business Partners, Employees, etc. It is compliance with the set of rules, procedures and operational structure which must be followed to balance the interest of all the stakeholders involved.
The scams like the Tata-Mistry fallout, PNB-Nirav Modi Scam, The Satyam scandal etc., happened because of the failure the complying with the principles of Corporate governance. Many theories, as discussed below in detail, address the challenges faced by the companies whilst ensuring the proper governance in the firm.
THE FOLLOWING THE THEORIES OF CORPORATE GOVERNANCE:
1. AGENCY THEORY: As the name suggests, in the agency theory, the owner of the Company hires the agent, that is, the manager or director, to manage the affairs of the Company in the best interest of the Company and the owner. The problem arises when the person so appointed works for self-interest and to secure his basic salary and does not work to increase the profit and life of the Company. When the agent is appointed, there is delegation of power, and there is separation of power and control from the hands of the owner. The agent is responsible for the decisions taken and the working of the Company.
PRINCIPLE ⇒HIRES ⇒ AGENT ⇒ WORK IN SELF INTEREST.
2. STEWARDSHIP THEORY : This theory was introduced by Donaldson and Davis (1989). Stewards in the Company basically means the directors or the manager of the Company. According to this theory, as a steward, when managers are given the power to work in the interest of the Company, they work responsibly for the organisational success and balanced growth of all the stakeholders—the work in the interest of the shareholders to maximise their wealth.
SHAREHOLDERS ⇒ EMPOWER THE TRUST ⇒ STEWARD
STEWARD⇒ ORGANISATIONAL SUCCESS⇒ SHAREHOLDERS
3. RESOURCE DEPENDENCY THEORY: For efficient working of any firm resources are required. The firm’s director has the responsibility to bring and make efforts to bring resources to the firm. These resources can be information, skill, suppliers, buyers, dealers, social groups etc to secure and enhance the organizational functioning, performance, and its success.
DIRECTORS ⇒ BRING IN RESOURCES ⇒ ORGANISATIONAL SUCCESS
4. STAKEHOLDER THEORY: According to this theory, the manager should take steps in the interest to secure good governance to improve the relationship and interaction between the various stakeholders involved, such as Investors, workers, board of directors’ shareholders, general public, regulatory bodies, Business Partners, Employees, etc. This theory implies that the director is responsible and accountable to a wide range of stakeholders involved in the Company.
This theory primarily focuses on balancing the interest of all stakeholders whilst making any managerial decision and that nobody’s interest is kept above the other’s and is not given supremacy and the decision are taken in the long run interest of the Company.
5. TRANSACTION COST THEORY: The transaction cost is the expense incurred while moving the thing from one place to another or conducting an economic transaction. The transaction cost can be monetary, extra time or inconvenience caused. The Company works by making contracts and each contract brings with it the compliance requirement and some transaction costs. This theory suggests that the Company’s decision should be such that it works to achieve the optimum organizational structure. It should be economically efficient so that the cost of exchange is minimised.
6. POLITICAL THEORY: This theory appeals to righteousness. The manager should gain the shareholders’ trust and votes rather than purchasing the voting power. This theory focuses on the government’s political influence in the working of the Company that the political power significantly influences corporate governance.
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very well articulated