Corporate Governance is a procedure and process according to which a company is

governed and controlled.1 It sets out rights, responsibilities and obligations amongst the
shareholder, the board of directors and the stakeholders.

This week’s DQ has a cluster of issues in relation to good governance. I will be answering
them in turn below.

Good Corporate Governance

Good corporate governance establishes effective decision-making2 within a company.
Companies with good corporate governance may maintain confidence, provide excellent
services, deliver improvement and attract investors.3 Good governance in a company is
based on honesty, clarity, accountability and openness all of which enrich public trust and
engagement.

Key Characteristics of the Five Theories

(a) Separation of Ownership and Control: Under this theory the shareholders as owners of
the company are separated from the directors who have the actual control of company.
Since the shareholders cannot expect the directors to watch over their investments, a
corporate governance mechanism is needed to oversee the directors’ activities. 4 It is most
pronounced among small companies and family-run companies.

(b) Agency Theory: it derived from the concept of the separation of “ownership and control”
and in the 1970’s this concept was further refined and now known as Agency Theory.5
Proponents of this theory are Jensen & Meckling and Fama, who argued that the board of
directors would act as an agent of the shareholders as their principals. Under this theory the
agents are likely to be opportunistic and as such there has to be a mechanism to counter
this.6 The agents will incur additional costs for this.

(c) Transaction Cost Economies: Nobel Prize winner Oliver Willimson developed this theory.
Unlike the Agency Theory, it explicitly uses the concept of corporate governance. According
to this theory, the company is a hierarchal structure, which runs the contractual
relationship. The main concern with the theory is with the efficiency of governance
structures.7

Abdoullah & Valentine noted that the theory faces difficulty of including interdisciplinary
matters related to organizational economics and legal sciences.
1
<http://stats.oecd.org/glossary/detail.asp?ID=6778> accessed 21 May 2014
2
Effective decision making is based on (a) a well-balanced accountability framework; (b) high standard of
conduct; and (c) strong financial performance and risk management system
3
See University of Liverpool Week 1 note; Companies with poor governance usually fail to detect or anticipate
seriousness of the companies’ financial condition.
4
Ibid
5
<http://www.havingtheircake.com/content/1_Ideas%20that%20shape%20the%20world/fact%20and%20
opinion/The%20theories%20behind%20corporate%20governance.lnk> accessed 21 May 2014
6
Separating the incumbency of roles of board chair and CEO can protect interests of the shareholders. This
theory leads to harmonised interests between the shareholders and the directors to maximise the company
value.
7
Sorin Nicolae, Borlea, and Achim Monica Violeta. "THEORIES OF CORPORATE GOVERNANCE." Studia
Universitatis" Vasile Goldiş" Arad-Seria Ştiinţe Economice 1 (2013): 117-128.
 (d) Stakeholders’ theory: Stakeholders are all people, groups and organisations who have
impact or influence in the company. It was developed by Freeman (1984) and focused on
the views of the corporate responsibility with regard to the categories of stakeholders. 8
Under this theory, interests of the stakeholders and not only just the interests of the
shareholders are taken into account.9 Because the board has to carry out balancing exercise
between the interests of the shareholders and the stakeholders, the board may not be
accountable to anyone.10

(e) Stewardship Theory: Unlike the Agency Theory, it argues that the shareholders’ interests
are maximised by shared incumbency of the directors’ autonomous roles. 11 Here directors
work as principles rather than as agents.12 Results of an empirical test fail to support agency
theory and provide some support for stewardship theory.13 This can be an effective
structure provided there are representations from the stakeholders.14

Most Closely Connected Theory

All of the above theories want to achieve good governance. However there are merits and
flaws with all of them. Even though the agency theory is the most dominant of all of the
theories,15 my thought is sliding towards the “stakeholders’ theory”. My thought depended
even further towards it because of the recent Pfizer’s takeover bid of AstraZeneca.16

Various Corporate Governance Codes of various Jurisdictions

Corporate scandal and collapse of high profile companies in the 1980’s led the UK to
produce Cadbury Report, the first corporate governance code.17 In 2006, the codification of
the directors’ duties by the Companies Act 2006 was the single most important reform in
the history of the UK Company Law. In 2010, the Financial Reporting Council (FRC) issued
guidance for UK stewardship code to improve relationship with investors, improve long-
term return to shareholders and enhance corporate governance.18

Surveys carried out in 2010 and 2011, were disappointing as the investors statement often
gave a tick box responses towards Stewardship theory whereas it was as opportunity to tell

8
Ibid
9
See n3
10
Ibid
11
Lex Donaldson, “Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns”,
Australian Journal of Management, June 1991, Vol 16 no 1 at 49-64
12
S. Letza, J Kirkbride, C. Smallman, X. Sun, “Corporate governance theorising: limits, critics and alternatives”
(2008) International Journal of Law and Management 17
13
Lex Donaldson, n8
14
S Turnbull, “Corporate Governance: Theories, Challenges and Paradigms” (2000) 1(1), Gouvernance: Revue
Internationale 28.
15
Royal Dutch Shell Plc Annual Reports
<http://reports.shell.com/annual-report/2012/servicepages/about_disclaimer.php> accessed on 21 May 2014
16
Shareholders cannot push the directors to do something for their own financial gain at the expense of the
destruction of a great institution like AstraZeneca,
<http://www.theguardian.com/business/2014/may/21/astrazeneca-directors-resist-shareholder-calls-
to-reopen-pfizer-talks> accessed on 21 May 2014
17
<http://corporategovernanceoup.wordpress.com/category/corporate-governance-codes/> accessed on 21
May 2014
18
Ibid
their side of the stories.19 At the end of 2012, the FRC introduced revised UK Corporate
Governance Codes and Stewardship Codes.

In the USA, Corporate Governance is dominated by the famous Sarbanes Oxley Act 2002 in
response to the misleading and fraudulent activities of the big corporations in the 1990s. It
ended self-regulation on financial reporting and established Public Company Accounting
Oversight Board, an independent, non-profitable organisation to regulate it.

In 2004, the OECD revised its principles of Corporate Governance which was based on
shareholder protection and residual monitoring by shareholders.20 The board is accountable
to the shareholders and the company. The shareholders must be treated fairly and should
exercise their voting rights.

Success or failure of the Theories Objectives

In 2009, the EU in its report identified failings of the corporate governance as one of the
main cause of the disastrous financial melt-down. Companies need to be free to drive it
forward to achieve its goal. But this freedom needs to be exercised within a framework of
effective accountability which will ensure good corporate governance.21

Introduction of the new code in the UK is intended to ensure more accountability in the
corporate culture. Recent review shows companies moved speedily in response to the new
code: provisions on annual director re-election and triennial external board evaluations saw
96% and 98%, respectively, complying in the first year.22 Indications are that it is working
but it is very early state to give a definitive answer.

19
Ibid
20
n3
21
<http://www.grant-thornton.co.uk/Global/Publication_pdf/Corporate_Governance_Review_2012.pdf>
Accessed on 20 May 2014
22
Ibid