Theoretical

Perspective of
Corporate
Governance
Week 2:

MBA 3rd Semester, 16 Sep 2024

The development of corporate governance → Agency Theory

2/2/20XX
is a global occurrence and complex area
that includes legal, cultural, ownership, and → Stewardship Theory
other cultural differences. Therefore, → Stakeholder Theory
corporate governance theories are relevant
→ Institutional Theory
to some countries and may be applicable at
a particular time depending upon the stage → Critical Theory
at which a specific country or group of
countries is. The company must either cater

P R E S E N TAT I O N T I T L E
to shareholders' perspectives or consider
the stakeholder's approach, emphasizing
the interest of diverse groups such as
employees, credit providers, suppliers,

customers, and the local community.

2
 Theories of Corporate Governance

Theories help us understand, explain, and give meaning to study. Theory helps us guess what will happen and
explore unidentified areas. It's harder to find the connection between attributes, variables, or facts when
research is done without a theory.
Theory name Summary
Agency Theory Agency theory identifies the relationship between two parties: A
(Adam Smith,1776) principal and their agent, to whom they delegate work.
Stewardship Theory Stewardship theory is an important theory of corporate governance
(Donaldson & which assumes that managers should work as a steward.
Davis,1991)
Stakeholder Theory Describes the the composition of organizations as a collection of various
(Freeman,1984) individual groups with different interests.
Institutional Theory Firms are not autonomous. They are embedded in a specific social and
institutional context or institutional framework that both constrains and
enables strategy and corporate governance

2/2/20XX P R E S E N TAT I O N T I T L E 3
 Agency Theory

• Origin in the economic theory, early 70’s American literature, Adam Smith (1776).

• Later agency theory was developed by Jensen & Meckling (1976), who define agency theory as contract between owners and
management.

• Separation of ownership (share holders as principal) & control (management as agent).

• Common principal-agent relationships include shareholders and management, financial planners and clients, and lessees and
lessors.

• A principal relies on an agent to execute certain business transactions and represent the interests of the principal without
regard for self-interest.

• Managers try to put their interest first by forgoing shareholders’ interests. Termed as Agency problem.

• As a result, cost of resolving this problem increases due to the involvement of several corporate governance mechanisms
and monitoring systems like auditing, budgeting and hiring outside directors on the board and giving monetary and non-
monetary benefits to managers

2/2/20XX P R E S E N TAT I O N T I T L E 4
 Agency Problem

Different researchers & economists categorised agency problem into three types.
1. Principal-Agent Problem: this problem started with the operation of a large corporation. Where the
shareholders assign the administration of business to managers, but managers are more interested in
maximizing their compensation rather than the interest of owners.
2. Principal-Principal Problem: This problem exists between the major and minor shareholders of large
corporations. Since the major owners have high voting power so they can take participate in the
decision-making process in their favour.
3. Principal-Creditor Problem: this problem, and conflict exists between owners and creditors due to the
financing decision of risky projects (Panda & Leepsa, 2017; Yusoff & Alhaji, 2014).
S O U RC E : YO U N A S A . , ( 2 0 2 2 ) , “ R E V I E W O F C O R P O RAT E G O V E R N A N C E T H E O R I E S ” , E U R O P E A N J O U R N A L O F B U S I N E S S A N D M A N A G E M E N T
5
R E S E A R C H . W W W. E J B M R . O R G
 How to resolve Agency Problem

• Incentive plan for managers help to maximise shareholder interest .

• Introduce outcome (performance)-based incentive contracts that lower managerial opportunism.

• several measures need to be taken by the board of directors such as the establishment of numerous
committees (Yusoff & Alhaji, 2014).

• The Board of directors plays an essential role in monitoring performance managers and aligning both
parties’ interests.

• The audit committee as a proxy of the board of directors works as a monitoring mechanism to control the
management activities and match with the shareholders’ needs.

• Agency theory claims that the appointment of independent directors is the key to the effective and
efficient performance of management (Fama & Jensen, 1983).

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 Agency Theory Model

Hires &
Principal Delegate
Agent
(interest in
wealth (Interest in
creation) Remuneration
)

Performs

2/2/20XX P R E S E N TAT I O N T I T L E 7
 Stakeholder Theory

• Stakeholder theory is further extension of Agency Theory.

• It is argued that agency theory has limited scope because it identifies the interest of shareholders only.

• The stakeholder theory suggests that a firm should create value for all stakeholders, not just shareholders
(Freeman et al., 1984).

• The stakeholder theory scope is considered broader because it covers the role of corporate governance
(Yusoff & Alhaji, 2014).

• This theory is based on the belief that managers should work in the best interest of all stakeholders and
the board of directors should monitor the performance of managers.

• Freeman (1984), argued that a stakeholder is considered as an organization or any individual who can
affect or affected by the organization decisions.

2/2/20XX P R E S E N TAT I O N T I T L E 8
Stakeholder Theory: not only owners & shareholder are interested in success
of the business but also the suppliers, creditors, employees, potential investors, government &
regulatory organisation, local community, lenders, trade associations, and the general public.

• The scope of the stakeholder theory becomes widened, all the members of society where business is
operating, workers of firms, suppliers of raw materials, local community become an important element of
stakeholders theory (Freeman et al., 2004).

• Stakeholder theory stipulates that a firm works to improve and balance the interests of its several
stakeholders in such a way that each stakeholder receives some level of compensation.

• Initially, stakeholder theory was embedded in the management discipline while with the passage of time
different amendments and views came under stakeholder theory and now considered an important theory
under corporate governance system.

• One of the main advantage of stakeholder theory is to consider and develop strategy for the
entrepreneurial risks (Barney & Harrison, 2020).

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 Stakeholder Theory Model

Investors

Board of
Shareholder
Directors
s

Firm
Community Lenders

Government

2/2/20XX S TAK E H OL D E R T H E ORY M OD E L 10

 Stewardship Theory
• Stewardship theory is an important theory of corporate governance which assumes that managers should
work as a steward.

• Stewardship theory is developed by Donaldson and Davis (1991) and Donaldson and Davis (1993).

• In contrast to agency theory, the stewardship theory presents a different perspective of management, where
managers are considered stewards who will act in the best interest of the shareholders (Chrisman, 2019).

• The fundamentals of stewardship theory are based on psychology and sociology.

• This theory assumes that the managers will be always work in the best interest of the firm, they will protect
and make profits for shareholders.

• The success of the firm tightly encompasses management commitment and when the shareholder's wealth
will be maximized, the stewards will be also benefited in terms of remunerations (Abdullah & Benedict, 2009;
Klepczarek, 2017; Yusoff & Alhaji, 2014).

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 Stakeholder Theory Model

Empower & Trust

Shareholder Stewards
s (Empower (Maximize
& Trust) Wealth)
Protect & maximize Wealth

2/2/20XX P R E S E N TAT I O N T I T L E 12
 Theories of corporate Governance

Agency Theory Stewardship Theory Stakeholder Theory

→ Agency theory explains the → Assumes that managers should → Stakeholder theory is the further
relationship between agents work as a steward. extension of agency theory.
(management) and principals → Managers are considered → The stakeholder theory suggests
(shareholders). stewards who will act in the best that a firm should create value
→ As a general rule, shareholders interest of the shareholders for all stakeholders, not just
do not possess the requisite (Chrisman, 2019). shareholders.
skills to run corporations. → They will protect and make profits → the stakeholder theory scope is
for shareholders. considered broader because it
→ Principals need shareholders’
investments to run the → When the shareholder's wealth covers the role of corporate
corporation (Schroeder will be maximized, the stewards governance.
et al., 2010). will be also benefited in terms of
→ This theory is based on the
remunerations.
→ Shareholders are interested in belief that managers should
firms profitability and → The unique feature of stewardship work in the best interest of all
management may posses theory is to enrich trust in stakeholders and the board of
different goals. managers which is lacking in the directors should monitor the
perspective of agency theory. performance of managers. 13
 Any questions: You are welcome to ask

Thank You
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