Trace and Evaluate the Various Theories of Corporate Governance Finance Essay

Corporate governance in itself is the aggregate of two distinct disciplines of corporation and governance. Corporations that were once viewed as the sole property of its owners refers to the group of individuals intentionally working together to achieve certain goal or the set of goals organized in a specific legal framework. These corporations presently require to be incorporated through certain procedures and work in the broader context of state. Parties responsible for the smooth functioning of these corporations range from shareholders' to stakeholders. However governance refers to the ways of direction and control .It encompass the ways in which the corporations' works are being organized and defined. These ways include the rules, regulations and standards set by corporations and government for ensuring governance. Together corporate governance refers to the process, structure and information used for directing and overseeing the management of corporation Development of the subject traces back to 18th and 19th century when the word corporation actually was considered as a body responsible for ensuring public interests .It was managed by a single owner who himself was responsible for all operations and outcomes of this unincorporated business. Running of business raised questions relating to ownership, management and effect on general public of this act. This time period lead to the emergence of certain philosophers and thinkers who gave their insights on the control of the business either in the form of debates or corporate theories. Corporate theories answer the questions of ownership and management of corporations with regard to its formation. They relate to the issues of shareholders relations with the company and the body entitled to own and control corporation. There by in direct link with the subjects of business efficiency and survival. Theories date back to 18th century with their existence in regard to settle certain altercations over the ownership and control of businesses. Broadly corporate theories can be divided in to the disciplines of political, stewardship, financial and stakeholder models that started and ended its debate on being a state property. Every theory presented thereby took its roots from the economic, social and political circumstances characterizing the situation. These theories are:

Political theories

Emergence of corporate theories started from the mid of 18th century in which corporations were created by special legislations for public benefits ranging from churches to schools. These corporations were rarely business corporations in the contemporary sense with state dictating their powers and purpose. It was then that concession and fiction theory were presented defining corporations as state property and making the role of state central to its ownership and control. By making the role of state central to corporations, corporations became a mere vehicle to follow the rules and regulations laid down by the state and to work in the best interest of the state by following the laws and working for state benefit. There by creating a corporate governance environment based on trust and commitment towards benefiting the state. State control actually led to the development of business sector through strengthening the economic makeup whereby people were not fighting for ownership purposes but for giving more and better results to state .More over it was actually this period that led to industrial revolution with advancements in textile, roads, railways along with advancements in the standards of living. Although these theories were replaced by a number of new thoughts but at last ended up to the present century with the same concept with which the debate was started: "state control" i.e. asset partitioning theory.

Financial theories

With the introduction of SEC and other legal regulatory bodies in the 19th century responsible for the incorporation of the corporations, owners became more interested in forming the companies that were actually monitored by its people; appointed as managers. These managers were appointed as people responsible for running and increasing the profits of the company without any interest or share in the corporation. In essence to that aggregate theory was presented which stressed on giving preferences to the shareholders with the sole purpose of corporation being increasing the shareholders' investment. Besides this Berle supported the claim of aggregate theory by claiming the sole purpose of the company is to maximize shareholders wealth. However, these theories ignore the social, economic and psychological impacts of the corporations. In a way or other they fail to fulfill any safety, belongingness, esteem and self-actualization needs of workers. These passive owners had no interest in the corporation and the workers. Another viewpoint was presented by Lord Deming who said that the court must examine the corporation as a 'single economic unit' rather than a strict legal form. With the sole purpose of corporation being profit maximization economic theory supported shareholders but it assumed that the firm has perfect certainty about its activities which somehow is not possible in today's world because of intense competition, societal and environmental challenges. Financial model was further supported by the nexus of contract theory and agency cost theory which stressed on the contractual and principal agent relationships between the shareholders and the managers. These theories however failed to build the trust environment with in the corporation as agents (managers) were treated as costs to be monitored and controlled for following set policies. The main problem with agency theory being the introduction of methods to reduce agency cost, any manager could be fired on the grounds of increased cost .It was during this decade that the owners got power and the economy suffered in shape of various scandals that resulted in part due to the enhanced self-interest of the owners .However this could also be viewed as a positive remark as this mistrust led to the introduction of various corporate governance committees and acts e.g. OECD plus an awareness towards ethics and CSR

Stewardship model

These theories entitle managers stewardship of the corporation. These theories actually emerged due to the increased awareness and investment by the managerial class in developments such as infrastructure along with the emergence of wealthy middle class and relatively risk free investment due to low competitions. Corporate realism theory viewed managers as the authorities responsible for defining the company's objectives with the company being a real entity in itself. However it didn't define the limitations of this power plus managers exercised economic power that could prove harmful for society. Besides this with no authoritative head, managers are not accountable to either their owners or state and the financial bankruptcy could easily result but the positive point being the recognition of the corporation as a real entity separate from its owners. In addition to it the transaction cost theory defined corporation as a body in continuous transaction to the environment/market with resulting costs. These theories view managers as good stewards of corporation that can be trusted to work diligently to attain high levels of corporate profits. While the board serving as advisors the corporations is being controlled other way. These theories put the role of shareholders as passive owners with their function limited to the contribution of equity capital. However this could prove drastic as being trained runners of the corporation the managers can easily draft frauds. Along with this if managers are authorized to exercise enormous power in the corporation the elements of respect and accountability will be completely lost. Hence these theories contribute to corporate governance by way of increasing the interest of the managers in the business. This increased interest may or may not lead to the development of the company but for sure raise the standard of living of these middle class managers.

Stakeholders' model

Stakeholders model focus on value creation. These theories put corporation's self-interest ahead of its shareholders by declaring that the corporation is entirely dependent on stakeholders' resources to create value. Hence firm should exist to work in the interest of these stakeholders' including public, government, customers, investors and the like. Stakeholder efficiency argument was presented when the shareholder supremacy saw a decline in 1980s.These theories actually focused on strengthening the economy through focusing on creating efficiency. Being the wider sector in front the workers not only lead to enhance the financial sector of the corporation but also enhance performance management of the corporation as the workers get more alert in satisfying the needs of the wider community and providing quality products. Moreover, it follows the utilitarian principle of greatest good for greatest number of people hence fulfilling the core principle of corporate governance by satisfying the legal obligation to all stakeholders and smoothing the relationships between company's management, its shareholders, board and other stakeholders. Corporations in a sense became more socially responsible. All these theories in way or other contributed towards creating a good corporate governance environment as is evident in today's prosperous and accountable businesses around e.g. Nike, Addidas, Siemens to name a few. These theories make it evident that corporate governance must adapt to important relationships with uncertain cause-effect influences on matters that range from survival to sustainability. Outcomes of financial theories in the shape of scandals helped in directing and controlling organizational activities by establishing rules, structures and procedures for decision making i.e. a major purpose of corporate governance. Corporate governance is a tool for socio economic development holding balance between economic, social, individual and communal goals as it leads to the minimization of malpractice and fraud. This prevention in my view brought about by control of business by an authoritative body such as state .State control lead to the efficient use of resources by aligning the interests of individuals, corporations and society. It was the creation of this good corporate governance environment that improved the communication within and across border, lead to open and transparent systems along with enhanced performance and better decision making. This good corporate governance environment strengthened the economy, lead to socio economic development and technological advancement of microchip era and raised the standard of living.

Cite this page