ACGD213

ETHICS AND CORPORATE GOVERNANCE

TOPIC 2:
INTRODUCTION TO
CORPORATE GOVERNANCE

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COURSE OUTCOME
At the end of this course, students should be able to:
 
CO1: Discuss concepts, theories and philosophy of ethics and corporate
governance

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Definition of corporate governance based on
The Malaysian High level Finance Committee on
Corporate Governance.
 The Malaysian High level Finance Committee on Corporate Governance defined
corporate governance as the process and structure and affairs of the company
towards enhancing business prosperity and corporate accountability with the
ultimate objective of realizing long-term shareholders value whilst taking into
account the interests of other stakeholders.
The definitions can be seen as concerned with both internal controls and board
structure as well as external aspects such as the relationship with shareholders
and stakeholders.
CORPORATE ETHICAL
GOVERNANCE AND
ACCOUNTABILITY
 Accountability is the obligation of an individual or organization to account
for its activities (including process + structure + affairs of the company),
accept responsibility for them (to enhance prosperity of the business on
behalf of the business’s owner), and to disclose the result in a transparent
manner such as responsibility for money and other entrusted property (to
fulfill and realize long term shareholder value)
 Governance refers to directing and controlling.
 Accountability refers to being answerable for the actions and decisions taken
(protect interest of other stakeholder).
 Corporate
Governance
Model

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The Board of Directors
 The Board of Directors (BOD) is responsible to set guidance, boundaries (policies, codes,
culture, and compliance to law, regulations, and rules) and direction (strategies, goals,
remuneration incentives).

 The BOD also involves in the appointment of the company’s Chief Executive Officer (CEO).
As the party who involves primarily in arranging resources of the company, the BOD is also
responsible to monitor the feedback (operations, policy compliance, financial reports) and
report to various shareholders and relevant government authorities.

 A BOD often divides itself into subcommittees that concentrate more deeply in specific
areas. These subcommittees are in charge with certain action and review on behalf of the
whole board. Usually, the subcommittees consist of audit committee, remuneration
committee, nomination committee and also governance or compliance committee.
THEORIES IN CORPORATE GOVERNANCE

3) 4)
Stakeholder Transaction
Theory Cost Theory

5)
2)
Managerial
Stewardship
Hegemony
Theory
Theory

1) Agency 6 CG 6) Resource
Dependency
Theory
Theories Theory

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THEORIES OF CORPORATE GOVERNANCE
THEORY INTERESTS BOARD MEMBERS MODEL

Owners and managers Owner / mandators

1) Agency Theory Compliance Model
have different interests representatives

Owners and managers

2) Stewardship Theory Experts Partnership Model
share interests

Stakeholders have different

3) Stakeholder Theory interests Stakeholder representatives Stakeholder Model

4) Transaction Cost Owners and managers Owner representatives Transaction Cost Model
Theory have different interests

5) Managerial
Owners and managers
Hegemony Owners representatives ‘Rubber Stamp’ Model
Theory have different interests

6) Resource Stakeholders and Chosen for influence

Dependency organizations have different Co-optation Model
with key stakeholders
Theory interests
1. AGENCY THEORY

An agency contract is one where

• one party (the principal) engages another party
(the agent)
• The agency theory is about the relationship between
the agent (managers) and the principal (owners).

Both parties are utility maximizers

Separation between ownership and control

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Agency problem
Due to the separation of between ownership and control,
the agency problem arise:

1) Moral Hazard
- Principal is unsure
whether the agent has
Example : Paying higher
performed their work
bonuses to managers
to their ability, due to
regardless company’s
self-seeking motives
performance
and ignoring the
implications for
f
Conflict o
shareholders

interest

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Agency problem
Due to the separation of between ownership and control,
the agency problem arise:

2) Adverse Selection

Where the principal Example : Managers have

cannot determine if the more information
agent is performing the compared to shareholders
work for which he is paid

Information
Asymmetry
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Agency problem
Agency problem also arise when shareholders & managers have different interest in:

• Agent – Prefer to invest in investment that has low risk

Risk aversion - Different • Principal – Prefer to invest in investment that has high risk
attitude towards risk to get high return

• Agent – maximizing compensations, security, status and

Dividend retention - boost their own reputation
Different Interest • Principal – maximizing returns on investments

• Agent – eager to take actions in short term run payoff

Horizon Problem • Principal – better served by long term benefits 

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Agency cost (to overcome agency problems)
• Cost that paid by shareholders to measure, monitor and control the
Monitoring cost activities and behavior of the managers.
• Example : Obtain external auditor

• Cost that relate to the debt contract between the principals and
agents (agents are bonded with principals by make sure that the
Bonding cost principals interest will be achieved)
• Example : Compensation/remunerations costs to BOD, producing
quarterly reports by agents

• Occurs because costs of monitoring and bonding make it impossible

Residual Loss to identify or stop all self-interested behavior by managers.

• Example : Earning management, fraud and accounting scandal

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Other solution for agency problem
Effective monitoring
Appropriate function by BOD in
contractual incentives observing managerial
behaviors

Capital markets players

acts as whistleblowers
Eg : analyst and rating
agencies

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2. STEWARDSHIP THEORY
Managers are not motivated by individual goals, but rather as stewards whose motives are
aligned with the objectives of their principals (shareholders/BODs)
This theory holds that there is no conflict of interest between managers and owners.

A steward protects & maximizes shareholder’s wealth through firm performance

Managers are incentivized to act; not as opportunistic agents, but as stewards to act in the
best interest of the owners
Become a good stewards in order to protect their reputation and secure their future career

To achieve: Favours boards having a majority of specialist executive director (accounting /

finance/ economic/ legal background)

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THEORIES OF CORPORATE
GOVERNANCE (cont.)
Corporate Governance Structure: Stewardship

Board of Directors

ALLIGNED
INTEREST
Shareholders Managers
3. STAKEHOLDERS THEORY
Firm that manage to optimize stakeholders satisfaction will be able to thrive
better than the company that only concentrates on maximizing shareholder
interest
s,
Employee
s,
customer
,
It holds that every corporation is created : suppliers
a re h o ld ers,
sh
e sto r, b a nk ,
inv
society
• to serve more than just its shareholders
• serve a diverse range of people who have a legitimate stake in the
organization’s outcomes & performance

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 SHAREHOLDER THEORY VERSES
STAKEHOLDERS THEORY

SHAREHOLDER THEORY STAKEHOLDER THEORY

Objectives Maximize shareholder returns Balance the shareholders’

financial interest against the
is to:
interests of other stakeholder

Linked mainly to profitability Short & long-term gain, profit

Focus to: & sustainability, power &
(Negative consequences) accountability

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 4. TRANSACTION COST THEORY
It is impossible to have a contract which perfectly aligns the interest of principal and agent
in a corporate control situation.
It involves managers’ discretion and they are more likely to be involved in opportunistic
behaviors.
Closely related to agency theory
• Views the firm as governance structure
• Assumptions
•Manager operate under bounded rationality  cost of time & resources are limited
•Manager are given to opportunism  cost of monitoring behavior (to avoid
tendency of mislead, distort and confuse the other party in the contract)

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5. MANAGERIAL HEGEMONY THEORY
A situation where a social group or class is ideologically dominant
(e.g.: management of the business)

The management is said to have more influence than the board in decision
making process

SOLUTION: It believes in legal intervention to modify board composition &

function to favor the management side in future happened when:-
• informational dependence on management is high
• management influence the procedures for selecting board nominees
• the characteristics of the directors (secure board seats and associated benefits)
• the social and time constraints on board members that may hinder their ability
to monitor management effectively (lack of knowledge of company’s affairs)
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THEORIES OF CORPORATE
GOVERNANCE (cont.)
Class and Managerial Hegemony Theory
◦ Managerial hegemony theory views that the management is more influential
compared to the board.

◦ Directors, according to the class hegemony theory, view themselves as an

elite group in the company.

◦ The real power in corporate governance lies with the board (the power to
control the management).
6. RESOURCE DEPENDENCY THEORY
◦ Resource dependency is defined as the reliance of a company on external
inputs, e.g. capital, energy, labour and materials.
◦ This theory argues that a board exists as a provider of resources to executives
in order to help them achieve organizational goals.
◦ Creation of linkages between the company and its external environment
through the board: Companies that create linkages can improve their survival
and performance.
INTERNAL CORPORATE GOVERNANCE MECHANISM
CG Mechanisms Internal CG Controls
Legal Internal control procedures
requirements
Auditor and Monitoring by BOD
board
Codes of Best MCCG 2007, 2012, 2017 and 2021 
Practice
Audit Implement Internal auditors
committee
Monitoring of shareholders
Shareholders • Remuneration
• Balance of power

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 EXTERNAL CORPORATE GOVERNANCE MECHANISM

Market Competition Demand for an

(Best CG practiced in Assessment of
company, best standing Performance Government
in the market – Information (Audited Regulations
reputation, image, Financial Statement by
credibility) 3rd parties)

Managerial Labour
Media Pressure Takeovers (Buying Out
Market (Employee
(implement Of One Company By
Compete For The Best
whistleblower policy) Another - acquisition)
Satisfying Job)

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CORPORATE GOVERNANCE DISCLOSURE
TWO MAIN COMPONENTS OF
DISCLOSURE ON CG

Statement of
Corporate
Governance

Statement
of Internal
Control

Part of Integrated Annual report

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DISCLOSURE
E.G.:

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SIGNIFICANCE OF CORPORATE GOVERNANCE

COMPANY SHAREHOLDERS COUNTRY

• helps to prevent • Maintain /enhance • Have market

corporate scandals, long-term shareholder confidence
fraud, and potential values • attract long term
civil and criminal • Existing shareholders investment capital
liability of the will be loyal to the • sustain economic
organization company (shareholder growth
• enhances the feel more secured for • ultimately enhance
reputation of the their investment) nations overall wealth
organization and welfare
• makes it more
attractive to
customers, investors
and suppliers.

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SUMMARY - TOPIC 2
Definition

CG Model

Theories in CG

TOPIC 3 External
CG Mechanism
Internal

CG Disclosure

Significance of CG

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