The Four Models of Corporate Governance as Outlined by Letza - Essay Example

?Introduction Letza et al (2004 p242) undertake a critical analysis of the debates and theories of corporate governance. They identify that the fundamental discussions on the concept of corporate governance in organisations are centred on the two main perspectives that make up the basis of corporate governance: shareholder perspective and stakeholder perspective. Each of the two schools of thought present arguments to rationalise their points of view about the situation of corporate governance. Although this comes with some kinds of disagreement, each of the schools of thought attempt to justify their own views of corporate governance as superior and universal. Letza et al's journal was based on an extensive survey and critical review of the different theories and concepts that exist in corporate governance. Based on this comprehensive study, they identified four main approaches of perceiving corporate governance. This include: 1. Principal/Agent or Finance Model. 2. The Mypoic Market Model 3. Abuse of Executive Power Model and 4. Stakeholder Model Each of these models of corporate governance provide the basis for the perception of the importance and significance of corporate governance in organisations. Although each of them carry different merits, none of them seem to be universally accepted. This paper examines the four models of corporate governance as outlined by Letza et al (2004). The paper will undertake an analysis of the key features of each of the model. The paper will compare and contrast the approaches for each of the models and assess the future survivability of each of the concepts Corporate Governance Corporate governance refers to the ways that businesses are ran (Johnson, Scholes and Whittington, 2006). Corporate governance is about how the top level managers charged with stewardship roles in the organisation carry out the task of safeguarding assets and meeting the core vision and mission of the organisation. The development of corporate governance has come with several issues and situations that have had important impacts on the relationship between shareholders and strategic leaders of organisations. Major scandals that rocked the corporate world like the Enron matter played a role in facilitating rules and principles that define the corporate governance terrain today (Clarke, 2005). Important components of businesses played various roles in shaping corporate governance rules and regulations. Short Termism V Sustainability Most businesses are faced with a major dilemma of whether they should acquire short term results or work for the development of the longer term interests of the business. In drawing the balance between shortermism and sustainability, most businesses are concerned with four key things (Aras and Gowther, 2009 p282). These include: 1. Societal impact: That is the impact of the business on the society. 2. Environmental impact: The impact of the business on the natural environment. 3. Organisational culture: The relationship between organisational and internal stakeholders like employees. 4. Finance: The acquisition of adequate returns commensurate with the risks taken. These four important factors play a major role in determining the terrain and activities of the organisation. The major corporate collapses like Enron were attributed to blatant disregard for some key elements of these four components of businesses (Clarke, 2005). Thus, they all played roles in defining the creation of corporate governance rules and systems. Although there is still evidence of shortermism in corporate organisations, there is still some important roles that corporate governance standards and roles play in promoting sustainability in business (Eyatt, 2005). Risk Management One of the roles that corporate governance plays is that it helps in the creation of risk management systems to ensure that the board of directors monitor and control risks in organisations (Fraser and Harvey, 2007). “Company business models should be explained and the board should be responsible for determining the nature and extent of the significance of risks it is willing to take” (Copnell, 2010 p5). Risk management is the responsibility of the primary board however, it has this is attained through the distribution of this function to lower levels of the management structure and systems (Fraser and Harvey, 2007). Thus, internal audit systems and structures support management to remain responsible for the attainment of these ends. Stakeholder Demands and expectations Corporate governance also ensures that different people who have interests in organisations get their interests protected as normal (Letza and Kirkbride, 2004). The relationship with other stakeholders forces the people charged with corporate governance to balance their demands for the attainment shareholder needs and stakeholder needs. Hence, corporate governance gives room for ethics to ensure that all stakeholders' needs are attained in all situations (Rose, 2007). Also, ethics education and shareholder desires are fundamental, however, the longer term attainment of this end is the core of corporate governance. Shareholder Value & Shareholder Activism Shareholder value rules the Anglo-American corporate governance system (Gamble and Kelly, 2007). This is because as part of Friedmanism, shareholders are the essence for business operations. As such, businesses can be viewed in the light of shareholders who pool their resources for the attainment of profitability. And without shareholders, there can be no businesses. A shareholder activitist is “somebody who perceives an opportunity for change will add value, probably over quite a short period, but not necessarily over a very short period and actually wishes to crystallise that value and take steps through becoming an activist shareholder in that company” (Wearing and Millo, 20100). Shareholder activists are prepared to be involved in the company for the sake of its longer term value. As such, they seek to find ways of ensuring that all the demands and expectations of the organisation are met appropriately through corporate governance. Integration to Regulatory Systems The inclusion of regulations by global bodies like the Organisation of Economic Cooperation and Development (OECD) enables governments to regulate investors, corporations and stakeholders (Jessover and Kirkpatrick, 2005). This has promoted some degree of harmonisation throughout different countries around the globe. Approaches Thus, from the core elements of corporate governance which include risk management, regulation of shareholder and stakeholder expectations, compliance to regulatory systems, and balancing short term goals with long term goals, the different approaches to corporate governance can be examined with some degree of critical analyses. In doing this critical analysis, it will be worthwhile to examine the proponents of each theory, the purpose, background, counter argument and core propositions Principal/Agent Model This theory indicates that the purpose of corporations is to maximise wealth of shareholders. In other words, this theory indicates that businesses are set up to produce optimum returns on investments for shareholders (Jensen and Meeking, 1976). However, shareholders do not form part of the day-to-day operations of the business. As such, the only way that shareholders' needs and desires can be met is through a set of regulations and rules that can be invoked to ensure that the power and control of shareholders are attained. The theory also acknowledges that the agency problem is the main issue with management and running of organisations. According to Jensen and Meckling (1976), the agency problem occurs because the owners of the company allow stewards to carry out business for them. In other words, the strategic level leadership of organisations are employed and empowered by the owners of the business to carry out activities in the name of the organisation. Hence, they act as agents of the shareholders. The agency problem arises because the stewards charged with management of affairs in the entity are likely to have an interest that is different from the original motive of maximising profits. This could be the attainment of their own personal needs and other conflict of interest issues. Thus, corporate governance is to examine the most efficient way of governing the principal-agent relationship. Corporate governance attempts to provide rules and regulations that relationship between principals and agents. The agency theory simplifies the idea of interaction between principals and agents by assuming that social relations and economic interactions are reduced to a set of contracts between principals and agents. Contracts facilitates exchange between the players in the organisation (Manne, 1965). As such, the principal-agency theory supports corporate governance by arguing that it provides the basis for the creation of rules and regulations for the regulation of activities between principals and agents. Myopic Market Model The myopic market model is shareholder focused. It is similar to the principal-agent theory. This is because it views corporations as entities that exist to maximise shareholders' wealth. Thus, it also supports a different view of organisations and stakeholders. The concept goes on to claim that the Anglo-American corporate governance system prevents important things like short term return of investments, short term profits, short term management performance and short term stock market prices (Charkham, 1994). As such, the corporate governance system seem to stand in the way of organisations' need to take risks that will bring them higher returns. They claim that corporate governance seem to support a view that argues that hostile takeovers are rife and every organisation is in danger. With this arguments, proponents like Sykes (1994) argue that managers seem to be constrained by corporate governance and seek to take up steps that will force them to take measures that will prevent hostile takeovers rather than long-term performance. This model seem to argue that governance's problem has to do with excessive desires to stay away from taking risks that brings appropriately huge returns. As such, the model seem to advocate for a competitive corporate governance system which needs to be based on the short-term interest of shareholders. As such, there would be high risks taken with the hope of getting higher results. This is is because the proponents argue that there is a strong chance that the current system might even fail to promote sustainability of businesses. As such, it is in the rightful order to get the stewards and managers of businesses to focus more on short term visions and goals. This way, there will be the creation of long term relationships with relevant stakeholders, particularly shareholders. The school of thought developed after the takeover movement of the 1980s became popular (Letza et al, 2004). The takeover movement argued that organisations which failed to meet all the relevant requirements of the society had to be taken over violently by those that were up to the task. In this quest, the goal of corporate governance was shifted from safeguarding assets to getting managers to attain short term goals that would prevent violent take over bids. As such, the theory was meant to prove that the market was dysfunctional and corporate governance had to support shareholders to increase their loyalty and voice. This will reduce the ease of shareholder exit. Also, it argued for the emerging relationship between investors and companies. Finally, the theory sought to offer longer term solutions to different groups within organisations. Abuse of Executive Power Model The abuse of executive power model is also similar to the principal-agent theory. However, it sees corporate governance as a response to threats and the increase in the volume of corporate scandals. The theory is steeped in the fact that there is widespread abuse of executive power. This is because there is excessive power that is vested in the hands of management (Hutton, 2005). This means that management uses the excessive power to serve their own interest at the expense of the interest of the shareholders. As such, corporate governance had to intervene to prevent abuse of power. Hutton was writing after the corporate scandals involving Enron and Worldcom. As such, the whole theory was based on the fact that power corrupts and absolute power corrupts absolutely. The theory asserts that when there is too much power given to management, they end up using it for their own gains. In the case of Enron, they sought to use their power to cover up all the accounting frauds until it exploded beyond their power. This means that corporate governance can and must be used as some kind of tool to prevent such self serving activities. Keasey et al (1997) therefore state that corporate governance sets up constraints for the executive. It does this through some important steps: 1. Shareholder decisions become binding on many elements of organisational affairs. 2. Transparency and the requirements to disclose information about important aspects of the organisation. 3. Non-executive directors who seek to supervise and control affairs amongst the board. 4. Audit processes and procedures that ensures that there are checks and balances. 5. Protection of liquid assets of a business from abuse by the executive. According to Kay and Silberston (1995), the abuse of executive power model is important because the principal-agent concept does not seem to be relevant in the present time. As such, there is the need for the abuse of executive power model to provide checks and balances to ensure that executive members of organisations are given clear boundaries and they are monitored so that they do not overstep their boundaries. The concept evolved due to the problem of managerialism. This is because for some time, managers were given too much power. As such, it was not uncommon for managers to abuse power in a serious and pervasive manner. As such, this model came in vogue to ensure that managers occupied a trusteeship role rather than one where they could have unfettered powers and control. For solutions, there are some checks and balances like statutory changes in governance, fixed four year terms for CEO's, independent nomination of directors and increasing the powers of non-executive directors. Stakeholder Model The stakeholder model is built from a variety of fields like ethics, philosophy, political economics, law and organisational social science (Solomon, 2007 p23). This is because there are large numbers of groups of people who are involved in various relationships with organisations and their rights need to be recognized and respected. Freeman famously describe a stakeholder to be “any group or individual who can affect or is affected by the achievement of the organisation's objectives” (1984). Blair argues that multiple firm stakeholders have risked various “investments” in order to support the attainment of the organisation's objectives (1995). As such, there is the need for moral rights or legislation to ensure that an organisation is responsive to the claims of these stakeholders. Under the stakeholder theory, corporate governance is seen as the maximisation of stakeholders' wealth in order to ensure the long term survival of the organisation. In other words, this concept seem to support the claim that there are different styles of capitalism and the best is one that ensures that all stakeholders are recognized and respected. The concept seek to ensure that there are business ethics included in organisations' affairs. Also, it ensures that employers and other entities in the organisation are respected and honoured throughout the existence of the organisation. Comparative Analysis The principal-agent model is inward looking. Any theory that factors in any other external matter tends to reject it as a proper theory. This is because it does not look at any other thing but the owners and the stewards of an organisation. Hence, if issues with the market, stakeholders and any other external entity is brought to play, the theory becomes invalid. The myopic market model is quite similar to the principal-agent theory since it argues for the focus of organisations on shareholders' interest. However, it also argues for the longer term development of organisations and this is similar to the stakeholder model. The main weakness of the myopic market model is that it is based on a market that had issues and was open to panic and similar circumstances. The abuse of executive power model is a practical view of corporate governance as a tool for the control of principal-agent relationships that has been abused. In other words, it become common because the principal-agent concept was not strong enough to control shortfalls and abuse of power. As such, under this theory, corporate governance is seen as a system meant to limit the power of managers to mere trustees who represent the best interest of shareholders and other stakeholders. The stakeholder model seem to be based on the long-term survivability of businesses. This is because it is believed that organisations can survive into the future if they discharge their obligations to all relevant stakeholders. However, the concept is put at odds by the principal-agent model which ensures that organisations focus on their shareholders' wealth maximisation rather than stakeholders who might not make any short term economic impact on the organisation. Future and Survivability It appears that the survivability of the myopic market model is quite limited by the change sin the markets .this it was propounded when the markets were quite problematic. Now that most people are following other arguments and models, it is likely to die out quickly. It also appears that the abuse of executive power model has come to take over from the principal-agent theory. This is because the theory seem to lack important checks and balances necessary for the attainment of proper results. Also, the stakeholder model seem to be gaining popularity around the world. This is because it supports the recognition of the rights of different people in every society affected by an organisation's affairs. Conclusions The evolution of the concept of corporate governance can be traced to four main concepts and proponents: principal-agent model, myopic market model, abuse of executive power model and stakeholder model. Basically, corporate governance involves risk management, short-termism v sustainability, shareholder V stakeholder needs amongst others. It is apparent that these debates find their ways into the very foundations of the four concepts that led to the need for corporate governance. Principal-agent model seem to view management as a stewardship function that needs to be checked to ensure that they carry out the interest of shareholders. The myopic market model reacted to the short-termism that was being promoted ahead of sustainability. The abuse of executive power model reacted to widespread abuses by the principal-agent model which needed to be checked. Also, the stakeholder model attempted to incorporate other important stakeholders in the corporate governance system to ensure that the long term survivability of firms were established. References Aras, G. and Gowther, D. (2009) “Corporate Sustainability Reporting” Journal of Business Ethics 87: 279 – 288 Blair, M. (1995) Ownership and Control: Rethinking Corporate Governance for the 21st Century Brookings: Washington. Charkham, J. (1994) Keeping Good Corporate Governance: A Study of Corporate Governance in Five Countries Oxford: Clarendon. Clarke, T. (2005) “Accounting for Shareholder Value and Stakeholder Interests” Corporate Governance Blackwell Publishing Vol 13 No 5 Copnell, T. (2010) “Up in the Air: Corporate Governance After the Credit Crunch” International Market Issue 55 Sept/October 2010 Eyatt, D. (2005) “Finance and Accounting marketing Objectives and Resisting Comittees” Corporate Governance Vol 5 No. 3 pp 139 – 155 Fraser, I and Ettany, W. (2007) “ Embedding Risk Management: Structures and Approaches” Management Auditing Journal Vol 2 No 4 2007 pp 392 – 409 Freeman, R. E. (1984) Strategic Management: A Stakeholder Approach Boston, MA: Pitman. Gamble, A. and Kelly, G. (2007) “Shareholder Value and The Stakeholder Debate in the UK” Corporate Governance Vol 9 No 2 April 2007 Hutton, W. (2005) The State We're In London: Jonathan Cape. Jensen, M. C. and Meckling, W. H. (1976) “Theory of the Firm: Managerial Behaviour, Agency Cost and Ownership Structure” Journal of Financial Economics 3 305 – 360 Jesover, F. and Kirkpatrick, G. (2005) “The Revised OECD Principles of Corporate Governance and Their Relevance to Non-OECD Countries” Corporate Governance Vol 15 No 2. Johnson, G, Scholes, K. and Whittington, R. (2006) Exploring Corporate Strategy London: FT Prentice Hall. Kay, J. and Silberston, A. (1995) “Corporate Governance” “National Institute of Economic Review 84: August pp84 – 97 Keasey, K., Thomson, S and Wright, M (1995) “Introduction: The Corporate Governance People: Diagnosis and Solution” Corporate Governance: Economic and Financial Issues Oxford: Oxford University Press. Letza, S., Sun, X., Kirkbride, J. (2004) “Shareholding V Stakeholding: A Critical Review of Corporate Governance” Corporate Governance Vol 12 Number 3 July 2012. MacNiel, T. and Li, X. (2006) “Comply or Explain: Market Discipline and Non Compliance with the Combined Code” Corporate Governance Vol 14 No 5 September 2006. Manne, H. C. (1965) “Mergers and the Market for Corporate Control” Journal of Political Economy 75 110 – 126 Rose, J. (2007) “Corporate Direction and Social Responsibility: Ethics V Shareholder Value” Journal of Business Ethics. Sykes, A. (1994) “Proposals for Internationally Competitive Corporate Governance in Britain and America” Corporate Governance 2 187 – 195 Solomon, J. (2007) Corporate Governance and Accountability Hoboken, NJ: John Wiley and Sons. Wearing, B and Milo, Y (2011) “Activist Investors in the UK Quoted Companies and Implications for Corporate Governance Centre for Business Performance Read More