Theories of Corporate Governance¶
Agency Theory¶
The relationship between principals, such as a company's shareholders, and agents, such as its directors, is defined by agency theory. This notion holds that the agents are employed by the company's principals to carry out tasks. The directors or managers, who act as the shareholders' agents, are given the task of managing the company by the principals. The agents are expected by the shareholders to act and decide in the principal's best interest. Conversely, it is not required for the agent to act in the principals' best interests while making judgements. The agent could give in to opportunistic behaviour and self-interest, failing to live up to the principal's expectations. The division of ownership and control is the central tenet of agency theory. According to the principle, individuals or workers must be held responsible for completing their duties and obligations. Agent priorities can be adjusted through the application of rewards and penalties.
For better understanding, Agency theory examines the relationship between the owners of the firm (principals) and the people who manage the firm (agents). It addresses the problems that can arise in a firm due to the separation of ownership and control, and attempts to mitigate the risks associated with this separation.
Key aspects¶
Conflicting Interests:¶
While principals generally want to maximize their investment's return, agents may be more interested in increasing their own wealth, power, or prestige, even if doing so is not in the best interests of the principals. For example, a manager might prefer to expand the company rapidly to increase their power, while shareholders might prefer that the company return some of its profits as dividends.
Information Asymmetry:¶
Agents usually have more information about the company's operations and the actions they take than the principals do. This can lead to a situation where agents may act opportunistically, taking actions that advance their own interests at the expense of the principals.
Stewardship Theory¶
Stewardship theory presents a counterpoint to agency theory by suggesting that not all managers (agents) are motivated by self-serving interests when making decisions on behalf of the owners (principals). Instead, it posits that managers, or stewards, are motivated by the desire to achieve the best outcomes for the shareholders, and by extension, for the organization.
stewardship theory encourages organizational structures that support decentralized decision-making, empower managers, and allow them to take ownership of their roles. This theory is often seen as more applicable in cultures where collectivist values are predominant and where there is a high level of trust in managers and executives. It can serve as a guiding philosophy in organizations that believe in intrinsic motivation and the inherent goodness of individuals in aligning with corporate goals.
Key aspects¶
Alignment with Shareholders' Interests:¶
Unlike agency theory, which assumes a divergence in the interests of managers and shareholders, stewardship theory assumes that stewards’ interests are aligned with the objectives of their principals. Stewards are intrinsically motivated to act in the shareholders' best interests because they find value in contributing to the success of the organization.
Governance Mechanisms:¶
While agency theory relies on external mechanisms like performance-based incentives and monitoring, stewardship theory leans more towards empowering executives and reducing controls. The idea is to create an environment of trust rather than one of surveillance, thereby encouraging stewards to act in the best interest of shareholders.
Criticism of Stewardship Theory:¶
One of the criticisms of stewardship theory is that it may be overly optimistic about human nature. Critics argue that it fails to account for the complexity of human motivations and the fact that some managers might act opportunistically if given the chance.
Stakeholder Theory¶
Stakeholder theory broadens the focus of the company's responsibility beyond the traditional view that the primary, or even sole, responsibility of a company is to its shareholders. Instead, it considers a wider spectrum of interests, arguing that there are other parties involved in the business—stakeholders—who are also impacted by the company’s actions and decisions.
stakeholder theory can lead to the development of policies and practices that seek to engage stakeholders actively, understand their perspectives, and address their concerns. It often requires mechanisms to listen to stakeholders, such as advisory panels, surveys, and open communication channels, and can lead to more inclusive and transparent governance practices.
Key aspects¶
Broadened Accountability:¶
Stakeholder theory posits that managers are accountable to a range of stakeholders who have a legitimate interest in the business. This includes not only shareholders but also employees, customers, suppliers, community groups, and other entities affected by the company's activities.
Intrinsic Value of Interests:¶
Unlike other theories that prioritize the interests of shareholders above all others, stakeholder theory asserts that the interests of all stakeholders have intrinsic value. This means that a stakeholder's interests are valuable in their own right and not only when they align with shareholder interests.
Corporate Purpose:¶
The theory implies a broader view of corporate purpose, which encompasses creating value for stakeholders and contributing to the well-being of society, rather than solely focusing on profit maximization for shareholders.
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