The Necessity of Corporate Governance Systems

Check out more papers on Economy Market Organization

Corporate governance is a necessary, important and comprehensive overview of what corporate and their directors must do in order to bring the largest benefit for the corporate as it include the structures, processes, culture and systems that engender the successful of the organization. It concerns the relationships among the Board of Director, the management team, the shareholders and stakeholders. As time passes, good corporate governance is a compulsory requirement in today’s corporate world by every stakeholder groups as it has become an important key for a corporate to success. Lacking of efficiency in corporate governance may cause the corporate to collapse. While, by having good corporate governance it may help to reduce the risk of corporate collapse happen, enhance the performance of the corporations yet it creates an environment that motive the manager to maximize the return on investment. Besides, it also helps to ensure long term productivity grows and increase the investor confidence. Therefore, transparency and accountability are the most important element in order to have good corporate governance. This is because it would help the organization to have a clear and creditable decision making. However, there are various theory have affected while developing the corporate governance. The main theories that are greatly influence the corporate governance concept and reformation is the agency theory, transaction cost and stakeholder theory.

Don't use plagiarized sources. Get your custom essay on

“The Necessity of Corporate Governance Systems”

Get custom essay

Agency Theory

Agency theory is defined as “the relationship between the principals, such as shareholders and agents such as the company executives and managers” (Abdullah.H, 2009). This theory is usually being use to examine the relationship between the principle and agent in order to determine how the agent (director or managers) archive to maximize the return to shareholders, while at the same time the managers/ director himself/herself does not own the share. However, this theory may not be practical for the director or managers when manage the corporate in real life. This is because; suppose that the director being appointed by the principle is being expected to act and make decisions in the best of principal’s interest and full fill all the their needs. However, the director/managers has his/her own objective too, as they might not be working in the best interest or act partially in the best interest of principle.

They might be misuse his/her power and committing “moral hazards” such as shirking duties to enjoy leisure merely to maximize their personal wealth, benefits, self-interest and reputation as they do now own the share of the corporate. Besides, conflict may be occurring between the agent and principle due to different interest being focus. The agent being appointed as director might be only focusing on short term benefit which may bring benefit himself/herself the most, while at the same time the shareholders are more focusing on long term benefit which may bring best interest to the company. Enron scandal is a real life that show that the management’s goals conflict with those shareholders. In this case, the auditor manipulated the financial arrangements among themselves by using the special purpose entities (SPEs) transferred fund to some of the Enron’s director and conceal the large loses that Enron is facing. Ultimately, announced bankrupted and leaving Enron shareholders without anything.

However, the agency problem can never be perfectly solved due to divergent behavior of manager but in order to predict such problem happen again, agency theory suggests that a system needs to be carry out in order ensure that the agents are working on the best interest of the principle that they are representing. Jensen (1983) suggested that the principal-agent risk-bearing mechanism must design efficiently and must be monitor though the nexus of organizations and contract. Besides, from Enron case it also highlighted that there is a need to set up an independent non-executive director to monitor the action of executive director in order to ensure that the director is working on the best interest of the shareholder. In short, agency theory has greatly influence the reformation if corporate governance as it is an important set of propositions in the organizational economic discipline so that the employees are responsible for their task or decision has been made.

Transaction Cost Theory

Besides, transaction cost theory has also great influence in the reformation of corporate governance. The exposition of transaction cost theory is where the organization has become larger and became the market leader; in effect it turns to control the market by determining the allocation of resources. The organization started try to control the production, price movement in the market and the markets coordinate transaction. Therefore, the organization tent to extent their organization by vertical integration either forward or backward integration in order to create a boundary so that the organization could control and determine the price and production of a product. Besides, the organization could also reduce risk as the organization could avoid the risks that there is an increase of price in future yet could avoid the risk of dealing prices with supplier or retailer. Due to there is imperfect market condition, as there is too many buyers and limited resources, transaction cost economic has incurred. According to the theory of transaction cost economics it assumes that some individual are opportunistic, some of the time, at the same time it also stated that mangers are opportunistic by nature. (Soloman, 2007).

Due to there is limited resources, there will be an increasing of the market value of a product/ services, and this has created an opportunity for the managers and other economic agent to practice “bounded rationality”. According to Simon, bounded rationality defined as the behavior that was intentionally rational but only limitedly so. The managers will tend to satisfies him/her own self interest rather than maximize the company profit. They would try as hard as to organize transactions for their best interest. At the same time, arm’s length transaction will also occur during the negotiation. This is because the seller and buyers or the supplier and retailer will be acting in their own self interest during the negotiation session as there are limited resources/ substitute and this give an opportunity that bribery and “under table” problem occur. Therefore, in order to avoid these problem occur, the organization should have stuff rotation once a year in order to avoid there is close relationship between the manager and buyers. At the same time, transparent, integrity and openness should be practice among the organization, so that the information are open to disclose and the information give in financial statement is disclosing with honest and completeness and there is no hidden information. Besides, if there is related party transition occurs it has to be stated clearly in the account to avoid any misunderstanding.

Stakeholder Theory

The role of organization in the society, the impact of organization on the employees and environment has being highly focused and discusses over decade. Society nowadays has become more concern about organization business activity, the effect to environment and how they treat the stakeholder unethically. Therefore, stakeholder theory has been involved and has great influences on the reformation of corporate governance. The main concept of stakeholder theory is that the organization should concern on more sectors of society rather then only focus on the returns for organization and their shareholder. Stakeholder theory normally being viewed as a conceptual cocktail, as it emphasizes on the dependency of many different groups on the organization’s management, not only the shareholders but also the employees, customers, suppliers, creditors and the general public. There are too many problems rise in the real environment, as the organization nowadays are acting in so unethically way and they are only concern about their self-interest or to increase the organization profitability.

It highlighted that the social problem today’s are getting serious as the organization nowadays are acting so irresponsibility; they do not border about the damages and effect that they bring to the environment. Besides, in order to maximize him/her self interest, it causes fraud and cheating problem occur. Due to the organization didn’t act ethically as connected with what they are doing and unable to fulfill their basic responsibilities to their stakeholder. Therefore, corporate social responsibility (CSR) has fallen into as it relies on the separation between the business, social and ethic which the stakeholder theory intends to solve. It has become main issue for the organization, where the organization are being so encourage by the society to improve the way the they treat the stakeholder and the environment , yet it will influence the views of the society to the organization. However a major problem has arise, is there a measurement to measure the stakeholder welfare? Yet, there is no standard accounting measurement or market value measure that could measure the past or current organization decision brings effect on the stakeholder welfare.

Besides, when an organization takes into account of all the goals and involved themselves in the stakeholder activities, often there will be bring a higher cost to the organization yet will decrease the business performance. The manager may become ineffective to achieve the company goal in order to achieve “win-win situation” to the society and organization. At the same time, from the China economy performance shows that the society becomes worst when the organization is focusing on social goals.(Kim, 2010) Indeed, the stakeholder theory stated that the organizations should act responsibility and take into account of the stakeholder welfare as it the moral things to do so but it is very questionable to do so. As it is not a well-defined theory and it doesn’t show that by taking into account of the stakeholder welfare it may increase the organization’s stock and operating performance yet there is no prove that maximizing organization profit will bring harms to the society. Therefore, stakeholder theory is very questionable and it depends on the organization how to practice it.


In short, having good corporate governance is a major key in order for an organization to success. The corporate governance conceptual or theory is just providing a guideline for the organization in order to have improvement or being self-regulation. So that the organization would provide better services, bring less harm to the society and protect the environment. However, it maybe not practical and there is difficulty to practice in the real world as many organizations may not follow as what the theory said. An organization may fail in social goal but success in business, but an organization may not be success in social goal yet fail in business. At the same time, the major problem is there are lack of a framework, rules and regulation that every organization has to follow as what corporate governance said. Therefore, it is depends on how organization to practice it in order bring less harm to the society and protect the environment.


Did you like this example?

Cite this page

The Necessity of Corporate Governance Systems. (2017, Jun 26). Retrieved December 5, 2022 , from

Save time with Studydriver!

Get in touch with our top writers for a non-plagiarized essays written to satisfy your needs

Get custom essay

Stuck on ideas? Struggling with a concept?

A professional writer will make a clear, mistake-free paper for you!

Get help with your assigment
Leave your email and we will send a sample to you.
Stop wasting your time searching for samples!
You can find a skilled professional who can write any paper for you.
Get unique paper

I'm Chatbot Amy :)

I can help you save hours on your homework. Let's start by finding a writer.

Find Writer