Impact of Corporate Governance on Management Monitoring - Literature review Example

IMPACT OF CORPORATE GOVERNANCE ON MANAGEMENT MONITORING by Student’s name Code+ course name Professor’s name University name City, State Date Literature Review Corporate governance has been defined differently by different scholars. Thomsen (2005) defined corporate governance as the process through which rules, regulations, and laws that govern the working relationship between organizational managers and stakeholders are set. The stakeholders include financial institutions, board of directors, organization owners, suppliers, and employees. Dittmar and Mahrt-Smith (2007) add that corporate governance stands in the center of all the stakeholders and depends on the stakeholders. On the other hand, Bies (2004) defined corporate governance as a way of making managers of organizations responsible for the decisions they make towards the organizations. Westhead and Howorth (2006) indicate that corporate governance involves differentiating managers and owners of organizations and defining regulations and rules that direct the management of organizational resources. Management monitoring is one of the major components of corporate governance. According to Mousavi, Sadi, and Aliahmadi (2012), the major components of corporate governance include business ethics and practices, monitoring, committees and board of directors, management of organizational risks, communication, and legal and regulatory measures. The mechanism employed by managers while governing their corporations influence performance of the organizations they lead. Effective monitoring of activities of corporate governance and complying with organizational policies spearhead the improvement of performance. There is therefore a relationship between effective corporate governance with identification of opportunities that can improve profits of organizations when pursued. This can be achieved through implementation of periodic internal audits as this improves the adoption of an integrated and sustainable corporate governance strategy (Hassan, 2009). Corporate monitoring involves the use of various mechanisms classified into internal and external mechanisms. The internal and external mechanisms are grouped into regulatory, internal monitoring, and market. Market mechanisms may include shareholders, the labor market, and capital market. Capital market and labor market are normally implemented in almost all corporations and it cannot be easy to distinguish between them (Bies, 2004). Managers are normally anxious about their status in the market. Managerial labor market stresses on the performance of managers with regard to organizations that they manage. In case the performance of managers is not up to expected level, the manager loses its reputation and might not be significant in the current competitive market. Management monitoring by shareholders have been greatly analyzed (Mousavi, Sadi, & Aliahmadi, 2012). Management of organizations by board of directors is one of the facets of corporate governance. Board of directors with huge shareholding in a corporation have great stake in decision making and their decisions affect their investments. The level of a company ownership especially with regard to shareholders and managers affect the spread of control. Concentrated ownership enhances the shareholders’ ability to control and monitor an organization. On the other hand, dispersed ownership with regard to shareholders and managers weakens shareholders’ control. Studies have also investigated the influence of the size of board of directors on performance of an organization (Dittmar and Mahrt-Smith, 2007; Thomsen, 2005). An organization with many persons in the board of directors may face problems when it comes to management monitoring since there are high chances of the members being unproductive, ineffective communication, and possible free-riding. Dyer and Whetten (2006) found that the size of the board influences performance and monitoring of a company. However, Thomsen (2005) found that the larger the size of board of directors, the higher the level of performance because there is high likelihood of getting people with a variety of expertise and skills that would enhance performance. Board of directors who are self-governing and do not rely on management for decision making are very effective when it comes to monitoring. This is because they are not interested in the organizations’ profitability or do not have any relationship with mangers. They are therefore well placed to test managers by asking them about the progress of the organizations and provide them with direction that they need the organizations to take. Rehman, M. A., Rehman, R., and Raoof (2010) also support the findings by asserting that boards of directors who are self-governing are more alert as they monitor organizations. There can be tension when the roles of the chief executive officer and that of the chairman of an organization are done by a single individual. When the roles are done by one individual, the management might over do certain tasks and try to implement ideas that favor them at the expense of shareholders. According to Dyer & Whetten (2006), if the roles of the CEO and chairman are done by a single individual, the CEO will have the powers to make the management and the board to depend on each other and come up with resolutions that favor them. The amount and level of talents possessed by the board members has an impact on management monitoring. Members of the board should possess a wide range of talents and skills, including finance and accounting skills, in order to enhance effective management monitoring. Azim (2012) found that possession of financial skills by the management enhances the quality of services that board members provide to a company. Maury (2006) points that skills required by board members in finance can be obtained by either going through the formal education or reading materials related to finance. These means of acquiring skills provide the background knowledge required for understanding, interpreting, and forecasting financial performance of organizations. The number of meetings board members have in a year influences their ability to monitor management and companies. Holding many meetings in a year may show that the company is experiencing problems that need to be solved; on the other hand, holding very few meetings in a year shows that the committee members the company have no interest in the company therefore are not working towards making it better (Mousavi, Sadi, & Aliahmadi, 2012). Board of directors that meet many times do their work well as they have enough time to oversee and monitor the work of the management (Azim, 2012). Dyer & Whetten (2006) recommend that board members should meet regularly in order to increase the chances of providing shareholders with yearly reports that reflect the right performance of companies. The structure of the board and the members of committee present in a board affect the effectiveness of monitoring management by the board. Westhead and Howorth (2006) advice companies to constitute board structures with three groups of committee members: those that evaluate the financial performance of the companies, those that look at the payment structure of the companies, and those that nominate various company officials. Corporate governance mechanisms applied in businesses owned by families relate to management monitoring. Family businesses that are traded publicly do not experience a lot of problems when it comes to untying management and owners. This is because family owners get directly involved in the management of the companies and monitoring of managers via their contribution to the governance of the company (Maury, 2006). In contrast, publicly traded family businesses normally face the problem of monitoring shareholders due to the large percentage of their shares and direct control on board of directors thus are able to set targets or come up with policies that benefit them. Family businesses that lean towards practicing nepotism during hiring of managers or institution of board of directors make management monitoring very difficult and sometimes impractical (Westhead & Howorth, 2006). For example, when a parent hires or promotes a family member on a managerial position without following the right process therefore not considering experience, capability, and education, the business might have problems and being a family member, the hired or promoted person will be very hard to monitor. Involvement of family members in the managerial positions may result to problems when the members need to be entrenched. The family member may not be willing to relinquish his or her position in case of incompetence or engagement in unlawful activities. This can make a firm to either face legal problems or run at a loss due to ineffective management (Westhead & Howorth, 2006). Owners of family businesses always wish to pass their legacy to their grandchildren and generations to come (Dyer & Whetten, 2006). In this regard, such families tend not to like to venture into innovative strategies that are dangerous to businesses even if their outcome would improve profits in the long run. According to Thomsen (2005) owners of family businesses are normally risk averse therefore reduce the chances of their businesses growing. This normally creates squabbles between the family and external stakeholders as they are more concerned with reducing risks than making the business grow. Ownership structure of companies or corporations affects management monitoring. Organizations owned by many people or with many shareholders may closely monitor management activities and decisions because they are normally interested in protecting their interests in the company. They normally evade the management of the companies by external employees and if possible remain in the management and board of directors. Owners of companies also fear debt financing as this limits their ability to manage and practice as owners. However, according to Hassan (2009), organizations with many people as owners have high chances of getting huge loans from financial institutions thus have a strong financial base. To ensure proper management of their huge finances, the owners of such organizations normally employ highly qualified managers and closely monitor them to ensure that organizational strategies are implemented and organizational goals are achieved. However, Dyer and Whetten (2006) assert that large investors are poor in terms of diversification therefore have high probabilities of carrying the burden of risks. They normally want their interests to prevail thus normally do not let the interests of other investors and managers to work. Institutions that have invested in companies are another corporate governance avenue of management monitoring. Dittmar and Mahrt-Smith (2007) contend that such institutions have high chances of coordinating and influencing the interests of stakeholders. They include insurance companies and financial institutions. Corporate governance mechanisms can be changed by politics, which can either be for improving or deteriorating corporations. However, while there are many laws and regulations that govern corporate governance, competition of products and services in the market can sometimes shape the nature of corporate governance in a country. Even though competition in the market can shape corporate governance mechanisms, it cannot independently solve the challenges of corporate governance in entirety. In this regard, people who invest in businesses need to get good returns at appropriate time. Corporate governance mechanisms help in ensuring that this is done. This is because it assists in monitoring managers to lead companies and meet the desired goals. The decisions made by managers with regard to investment may reflect upon the desires on managers instead of the desires of investors. Hassan (2009) contends that management monitoring becomes a huddle in this case. However, many financiers continue to offer loans for managers to run their businesses. Mousavi, Sadi, and Aliahmadi (2012) gave some reasons why financiers continue to do so: first every individual or institution intends to maintain his or its reputation therefore is obliged to repay or honor the agreements they make with financial institutions. Building reputation is with the desire to convince future investors and financiers of the ability to repay loans in order to get more finance from investors. The second reason why investors give their money to manager is because investors are always optimistic with their investment plans. Thomsen (2005) explains that investors are normally excited about the share returns they are to get from their shares but do not look at the long term repayment effect. In addition, investors obtain the right to control the activities of the companies they finance. Once the managers violate or go against the rights as stipulated in the agreement, the financier has the ability to sue the manager and the organization. This indicates that the financier has some stake in monitoring managers of the organizations they finance. Shareholders also have a right to vote on important issues affecting companies such as acquisitions and mergers including electing board of directors who have direct impact on management. Corporate governance is very important at ensuring that investors get the money they invest back, shareholders get return on investment, and managers build their reputation by making organizations profitable and repaying financiers in time. Corporate governance mechanisms either hinder or promote effective management monitoring. Corporate governance mechanisms such as having independent board of directors enhance effective management monitoring since the decisions of board of directors are not influenced by managers. On the other hand, publicly traded family businesses that hire or promote their family members who might be inexperienced or unqualified hinder effective management monitoring. Corporate governance therefore has an effect on management monitoring. Reference List Azim, M. I 2012, “Corporate governance mechanism and their impact on company performance: A structural equation model analysis,” Australian Journal of Management. Bies, V 2004, “Corporate governance and corporate culture, the intercourse,” International Journal of Management, 66(2), 103. Dittmar, A. & Mahrt-Smith, J 2007, “Corporate governance and the value of cash holdings,” Journal of Financial Economics, 83(3), 559-634. Dyer, W. G. & Whetten, D. A 2006, “Family firms and social responsibility: Preliminary evidence from the S&P 500,” Entrepreneurship Theory and Practice, 30, 785-802. Hassan, H 2009, “The relationship between corporate governance monitoring mechanism, capital structure and firm value,” Accounting Review, 10. Thomsen, S 2005, “Corporate governance as a determinant of corporate values,” Emerald Group Publishing Limited, 5, 10-27. Mousavi, Z., Sadi, A., & Aliahmadi, S. 2012, “The evaluation of corporate governance monitoring mechanisms on capital structure in Tehran Stock Exchange,” International Journal of Business and Social Science, 3(2). Maury, B 2006, “Family ownership and firm performance: Empirical evidence from Western Europe corporations,” Journal of Corporation Finance, 12, 321-341. Rehman, M. A., Rehman, R., & Raoof, A. 2010, “Does corporate governance lead to a change in the capital structure?” American Journal of Social and Management Sciences, 1(2), 191-195. Westhead, P. & Howorth, C 2006, “Ownershp and management issues associated with family firm performance and company objectives,” Family Business Review, 19(4), 301-316. Read More