Corporate governance initiatives and theories

At national level, several countries have come up with reforms to prevent the occurrence of further corporate collapses and improve corporate governance practices.

THE realisation of the importance of corporate governance for the socio-economic development of countries has motivated several initiatives, at national and international levels, aimed at responding to the corporate governance challenges worldwide.

At national level, several countries have come up with reforms to prevent the occurrence of further corporate collapses and improve corporate governance practices.

Globally, it has become well-established that to strengthen companies, be they private or state-owned enterprises (SOEs), there must be continuous investment of capital and human resources, as well as, customer satisfaction and public confidence in the entities.

To be able to attain these objectives, companies need to do more than just create a track record of producing goods and services and having a reasonable market share.

They must have good and effective management and be perceived to be properly governed. Proper corporate governance is globally considered as an important tool to achieve these aims.

The concept of corporate governance came about as societies tried to effectively manage complex activities. While economists believe that there is no other way of managing transactions outside markets and corporations, social scientists believe that there are many other models where transactions can be managed outside the market and firms.

These include culture, the power perspective and cybernetic analysis, information theory, limited life firms, worker control and ownership, compound boards, self-regulation and self-governance.

Often individuals involved in corporate governance apply what they believe is common sense, when in reality they draw subconsciously on long-established economic theory and assumptions that are challengeable.

Agency theory

Some high-profile business frauds and questionable business practices in the United Kingdom, the United States and other countries have confirmed the belief that business managers do not act as bona fide representatives of shareholders and other stakeholders but act in self- interest.

Much of the contemporary interest in corporate governance has been concerned with mitigation of the conflict of interest between managers and stakeholders.

Berle and G Means (1930) argued that with separation of ownership and control, and the wide dispersion of ownership, there was no check on the executive autonomy of corporate managers.

According to neo-classical economics, the root assumption informing this theory is that the agent is likely to be self-interested and opportunistic.

This has resulted in the agent serving their own interests instead of those of the principal. Two situations then arise out of the principal-agent problem: moral hazard and adverse selection.

Moral hazard arises when the agent’s action or outcome of the action, is only imperfectly observable by the principal.

Resource dependency theory

Resource dependency ideas were originally developed by Pfeffer and Salancik (1978). They observed that the board, especially the non-executive directors can provide the firm with a vital set of resources both in the form of specific skills as counsel and advice in relation to strategy and its implementation.

For example, outside directors, who are partners to law firms can provide legal advice to the firm which otherwise could be more costly if privately sourced.

Resource dependency theory allows the company to appoint a board of directors with different expertise as required at different stages of the firm’s life cycle.

For instance, a young entrepreneurial firm, even if it is owner-managed, can look to its non-executive directors as a source of skills and expertise that it cannot afford to employ full-time. More mature businesses can rely upon the non-executive as a source of relevant market or managerial experience.

According to the International Journal of Governance (2000), directors can also bring resources to the firm, such as information, skills, and access to suppliers, buyers, public, policy makers, social groups as well as legitimacy.

Stewardship theory

Stewardship theory has its roots in psychology and sociology and holds that managers protect and maximise shareholders wealth through firm performance, because by doing so, their utility is maximised.

Unlike the agency theory, stewardship theory does not stress on the perspective of individualism, but rather on the role of senior management stewards, integrating their goals as part of the organisation.

It is argued that senior management are satisfied and motivated by organisational achievement and responsibility and organisations will be best served to free managers that are not subservient to non-executive director-dominated boards.

While the argument for trusting managers to run corporations in the interest of shareholders for professional and reputational reasons may appear sound, experience of Enron and others indicate to the contrary.

Stakeholder theory

The stakeholder theory was first expounded by Freeman (1984), advocating for corporate accountability to a broad range of stakeholders.

Stakeholder theory challenges agency assumptions about the primacy of shareholder interest. Instead, it argues that a company should be managed in the interests of all its stakeholders.

For instance, employees are regarded as key stakeholders and Blair (1999), agreed that employees just as shareholders, are residual risk takers in a firm.

She further argued that an employee’s investment in a firm’s specific skills means that they too should have a voice in the governance of the firm.

Apart from employees, other groups like customers and suppliers have direct interest in the firm’s performance, while local communities, the environment as well as society at large have legitimate direct interest.

Corporations should, therefore, give stakeholders a direct voice in governance and nominate representatives of minority owners, customers, suppliers, employees, and community representatives to the board of directors.

Political theory

The political theory argues that the allocation of corporate power, privileges and profits between owners, managers and other stakeholders is determined by how governments favour their various constituencies. It has now been observed that over the last decades, the governments have been seen to have a strong political influence on firms.

Transaction cost theory

Transaction cost theory was first espoused by Cyert and March (1963), and later described by Williamson (1996). Transaction cost theory is grounded in law, economics and organisations.

Its underlying assumption is that firms have become so large that they in effect substitute for the market in determining the allocation of resources.

In other words, the corporation can determine price and production. The transaction cost theory is an alternative to the agency problem where managers, instead of using their positions to create wealth for themselves, they arrange the firm’s transactions to their benefit.

Ethics theories

Ethics is defined as the study of morality and the application of business, which sheds light on rules and principle, which is called ethical theories that ascertain the right or wrong of a situation.

According to the International Journal of Governance (2011), these include business ethics theory, feminist theory, discourse ethics theory and post-modern ethics theory.

Business ethics is where the business managers in the course of doing business should consider the impact of the transactions on stakeholders and society that is the rights or wrongs.

This is because corporations have become so large that they impact the lives of people in terms of jobs, goods and services and the environment.

  • Munhenga is a human resources and corporate governance professional. — [email protected] or mobile: +263 772 380 340/ +263 719 380 340.


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