CHAPTER- 19 CORPROATE GOVERNANCE- AN OVERVIEW

Objectives of the Chapter

Introduction Issues in Corporate Governance Definition of Corporate Governance Difference between Corporate Governance and Corporate Management Theories of Corporate Governance Models of Corporate Governance Evolution of Corporate Governance

Introduction
Corporate governance is concerned with the way in which corporate entities are governed, as distinct from the way in which businesses within those companies are managed. It addresses various issues facing the boards of directors, which relate to the interaction with top management, relationship with the owners, other stakeholders and society at large.

Issues in Corporate Governance

Corporate governance addresses three basic issues: Ethical issues Efficiency issues Accountability issues

Ethical issues
Ethical issues are concerned with the problem of fraud, which is becoming widespread in capitalist economies. Corporations often employ fraudulent means to achieve their goals. They form cartels to exert tremendous pressure on the government to formulate public policy which may sometimes go against the interests of individuals and society at large.

Efficiency issues
Efficiency issues are concerned with the performance of management. Management is responsible for ensuring reasonable returns on investment made by shareholders.

Accountability issues
Accountability issues emerge as out of the stakeholders need for transparency of management customers and society at large, some of the accountability issues are concerned with the social responsibility that a corporation must shoulder.

Corporate Governance
Corporate Governance ensures that longterm strategic objectives and plans are established and that the proper management structure is in place to achieve these objectives, while at the same time making sure that the structure functions to maintain the corporation's integrity, reputation and responsibility to its various constituencies. Advisory Board of the National Association of Corporate Directors (NACD), New York

Difference between Corporate Governance and Corporate Management

Corporate Governance Corporate Management External focus Governance assume an open system Internal focus Management assumes a closed system

Strategy-oriented

Task-oriented

Concerned with where Concerned with getting the company is going the company there

Theories of Corporate Governance

The first theory of corporate governance (Theory of Macgregor) was based on the assumptions that humans are by nature trustworthy and act in good faith, with integrity and honesty. These beliefs are also reflected in the company law. The corporate governance concept believed that monitoring is required only to curtail the rare misconduct of humans working in corporations

Theories of Corporate Governance contd

The stewardship theory proposed by Donaldson and Davis in 1988 was also based on the same beliefs. This theory also accepted the assumptions on which some behavioral theories like Macgregors theory Y of human behavior are developed.

Theories of Corporate Governance contd

According to Theory Y The management of a corporation is responsible for organizing its productive resources like men, material, money and machines in the best possible way to accomplish the corporate goals. Employees by nature are not averse to behaving in accordance with the corporations requirements.

Theories of Corporate Governance contd

Every employee has an in-built motivation to behave in a way that will help the corporation to achieve its objectives. Some of the reasons put forth by critics of stewardship theory are: Separation of ownership from management. There is no single shareholder who holds a major chunk of equity capital.

Theories of Corporate Governance contd

The inability of small investors to directly monitor the activities of the corporation in which they have invested. Control over the corporation changing from the owners to the management, Divergent interests of the owners and the management. In 1976 Jensen and Meckling stated that there exists an agency relationship between the owner and the management.

Theories of Corporate Governance contd

This assumption gave rise to the agency theory. This theory assumes that the agent manager will not always take decisions that will maximize long-term owner value. Managers often take decisions, which further their own interests but are detrimental to the interests of the organization.

Theories of Corporate Governance contd

This theory states that agents/managers/employees cannot be trusted to act in the best interests of the shareholders and should be monitored and controlled to ensure that they follow the set policies, procedures and plans of the corporation.

Models of Corporate Governance:

Many models of corporate governance try to involve various stakeholders like shareholders, employees and financial institutions in the governance of the company. The models are: Anglo-American German Japanese Indian

Anglo-American Model
Board of directors Elect Own Creditors Lien Shareholders (owners)

(Supervisors)
Appoints and supervises

Officers
(Managers)

Manage
Company

Stakeholders Hold stake Structural framework Legal system

German Model
Supervisory board
Appoints and Reports to supervise Management board (including labor relations director) Employees and labor unions

Independently runs (day to day)

Company

Appoint 1/2

Shareholders (own)

Own

Japanese Model
Supervisory board (including president)
Rarifies presidents decision Consults

Appoint Own

Shareholders

President
Consults

Monitors acts in emergencies Provides managers Banks Manage Loans

Executive management (Primarily board of directors)

Company

Indian Model
The Indian model of corporate governance is a mix of the Anglo-American and German models. Corporations in India can be grouped into three categories: private companies, public companies, banks and other corporations. The founder, his family and associates closely hold the private companies and they exercise maximum control over the activities of the company.

Indian Model contd

In the case of public enterprises, the central and state governments choose the members of the board. Even after the disinvestment of some public sector companies, the government continues to have a considerable hold over the activities of the company. Here the interests of the stakeholders are given low priority.

Evolution of Corporate Governance

Earlier the government was expected to ensure good corporate conduct. Most shareholders believe that stringent government control could prevent malpractices of the corporation for fear of punishment. However, there was soon a growing realization that government was not always the best guardian of public interest.

Evolution of Corporate Governance contd

Shareholders began to feel the need for market driven coronate governance that would be more democratic and flexible. This led to the birth of self imposed corporate governance within the corporate system. The active participation of various stakeholders like shareholders, financial institutions, etc.; have strengthened the corporate governance mechanism and helped it to evolve beyond a set of static rules.

Summary of the Chapter

Introduction Issues in Corporate Governance Definition of Corporate Governance Difference between Corporate Governance and Corporate Management Theories of Corporate Governance Models of Corporate Governance Evolution of Corporate Governance