Benefits of Corporate Governance - Essay Example

Corporate Governance Introduction Companies are formed to achieve different objectives for their stakeholders. These stakeholders include the management, shareholders, employees, financiers, suppliers, customers, the government, as well as the community in which any company operates. For instance, companies need to create value for their shareholders, satisfy the needs of customers, remunerate their employees fairly, pay taxes to the government, act responsibly in accordance with their own rules and those set by the government and other authorities, honor their agreements with suppliers, manage risks, and so on. To meet all these demands, companies must have systems and rules to take care of all matters that affect their operations and their relations with various stakeholders. They must also make decisions regarding their operations in various aspects. All these issues can be said to fall under corporate governance. This purpose of this report is it to define corporate governance, to analyze the theories that relate to the concept, and to discuss the benefits of corporate governance in relation to the operations of corporations. Definition of corporate governance Many authors (Du Plessis, Hargovan and Bagaric 3; Solomon 12) agree that there is no single accepted definition of corporate governance. Reports on the management of companies in the 1990s simply defined corporate governance as the “system by which companies are directed and controlled” (Du Plessis et al. 3). However, according to Du Plessis et al., this definition does not seem to be helpful in making the meaning of corporate governance clear. Hence, over the last ten years or so, there have been more attempts at defining the concept. These new definitions introduce additional elements or aspects to the concept of corporate governance (3). One of the definitions of corporate governance that was used in the United States is that “corporate governance consists of all people, processes, and activities in place to help ensure the proper stewardship over a company’s assets” (Du Plessis et al. 5). The same statement noted that corporate governance involves the formulation and execution of processes to make sure that those involved in the management of a company properly use the talents, time as well as other resources that are available in the best interest of absentee owners. The difference between this definition and the first one is that it introduces the roles of stakeholders, even though it simply focuses on the management fulfilling the roles expected by a company’s owners. More recent definitions of corporate governance have attempted to include the roles of other stakeholders in the operations of a company or how such stakeholders are affected by the company. For example, in 2005, the Organization for Economic Co-operation and Development (OECD) defined the concept as “the procedures and processes according to which an organization is directed and controlled”. OECD also added that the structure of corporate governance indicates the distribution of responsibilities and rights among the various participants in the organization, who include managers, the board, investors and other stakeholders, and sets the procedures and rules for making decisions (n.pag.). Similarly, Stolt cited various authors who have defined corporate governance as the connections within the company and between the company and the environment in which it operates (2). Stolt also argues that corporate governance attempts to create a base for mutual trust among a company’s shareholders, management as well as the board by offering a system through which the aims of the company are defined and the means of achieving them are set and monitored (2). There is no doubt that these definitions take into account the role that various stakeholders of a company have to play to ensure that the company operates effectively and with openness. But perhaps one definition of corporate governance that considers many elements of an organization is that proposed by Du Plessis et al. as the system of controlling and supervising the conduct of a corporation and of creating a balance between the interests all internal stakeholders and other entities (governments, external stakeholders as well as local communities) who can be affected by the firm’s conduct, so as to ensure accountable behavior by companies and to attain the best level of efficiency and productivity for a company (10). This definition is clearer because it touches on various issues, systems and people involved in a corporation. The most important elements of the definition by Du Plessis et al. are that corporate governance is a system of regulating and supervising the conduct of a company, it takes into consideration the concerns of different stakeholders, it aims to ensure responsible behavior by companies, and has the decisive aim of achieving maximum profitability and efficiency for a company (10). Therefore, corporate governance can be seen as the process of balancing the interests of a company’s stakeholders and providing the means through the company can set and attain its objectives in a responsible way. Theoretical frameworks of corporate governance Three theoretical concepts can be used to justify the relevance of corporate governance systems and structures. These are the stakeholder theory, the agency theory, and the transaction cost theory (Fulgence 160). The relevance of each of these theories is explained in the following sections. The stakeholder theory The stakeholder theory has the view that a company’s management should have consideration for the interests of all major stakeholders of the company (Fulgence 160). The theory considers a company as an input-output model by bringing the perspectives of all players – customers, employees, shareholders, government, suppliers and all other members of the society – together (Fernando 50). What the stakeholder theory does is basically to facilitate a balance between the interests all internal stakeholders and external stakeholders of a company in the management practices of the company as discussed above. The theory has however been criticized as being vague in its call for liberalism since it is not applicable in practice by organizations (Fernando 50). Fernando also notes that opponents of the stakeholder theory argue that there is considerably little practical evidence to indicate a connection between corporate performance and the stakeholder concept. However, the need to consider the interests of all stakeholders is clearer when one considers the view that managers perform well in their organizational tasks when they make stakeholders the focus of their performance (50). Therefore, whether companies consider the stakeholder theory in their management or not, it is apparent that corporate governance may be more effective when all stakeholders are considered. The agency theory This theory is based on the separation between the ownership the firm and the management of the firm’s actions (Fulgence 160). According to Fernando, the agency theory views the owners of the company as the principals and the managers of the company as the agents. Also, there is an agency loss, which is the degree to which the returns to owners of the company decline in comparison to what would be the case if the owners of the company themselves were exercising direct control of the company (46). Therefore, agency theory is basically a contract between the owners of a company and the managers of the company, who have different interests (Fulgence 160). Agency theory indicates mechanisms that can be used to reduce agency loss, which include plans for managers which compensate them financially for maximizing profits (Fernando 46). Agency theory therefore implies that companies aim to make profits and they do so by remunerating members of their management teams so that they can come up with more ways to increase profits or reduce loss. The transaction cost theory The transaction cost theory is based on the point of view that managers of companies are characterized by bounded rationality and opportunism and for this reason, their actions should be monitored (Fulgence 161). Bounded rationality denotes the fact that human beings, as economic actors, are likely to be rational, but only to some extent (Harlacher 22). Opportunism on the other hand goes beyond the fact that human beings can act in self-interest and includes the point that people can have the tendency to mislead, disguise or confuse others for their own advantage (Harlacher 22). The transaction cost theory basically recognizes that managers of a company will act rationally in the transactions conducted by the company in order to maximize profits; but at the same time, it notes that as human beings, managers can take advantage of the resources (such as financial resources) available at their disposal and divert them for their own benefit. That is, managers organize transactions in their best interest, but their actions need to be controlled so that they not do not pursue their own interests and neglect the interests of the company (Solomon 22). Benefits of corporate governance There are several benefits of corporate governance. The first benefit is in relation to the gains that a company, its customers, its employees, its suppliers, its financiers, and other stakeholders derive from good management (Balachandran and Chandrasekaran 90). Since corporate governance ensures that there is consideration of interests of all the company’s stakeholders as required by the stakeholder theory, this is likely to increase competitiveness and improve the company’s reputation. For instance, corporate governance that promotes responsiveness toward employees motivates them to work toward achieving the company’s objectives and this increases the company’s productivity and competitiveness (Balachandran and Chandrasekaran 90). The second benefit of corporate governance is in relation to advancement of accountability and transparency. The rules of effective corporate governance promote disclosure as well as transparency within corporations and set boundaries of accountability for the actions and behavior of those involved in the operations, management and oversight of companies, such as the employees, executive management and board of directors (Hussain n.pag.). Because of corporate governance practices and principles such as transparency, disclosure and accountability, all those involved in the various activities of the company are likely to be promoting openness in their undertakings because of the guarantee that their actions are being monitored as indicated by the transaction cost theory. High levels of accountability and transparency in companies as a result of corporate governance also minimize wastages, corruption, risks and mismanagement of company resources (Balachandran and Chandrasekaran 90). The third benefit of corporate governance regards clarification of the roles of key stakeholders (Hussain n.pag.). Corporate governance defines the roles of boards of directors, management and the owners of a company. This makes it possible to avoid conflict between the various arms of the company. As noted by the agency theory, there is a contract between the owners of a company and the people to whom they entrust the responsibility of managing the company. Clarity of roles helps in creating a distinction between what is related to the owners of the business and what concerns the company’s management. Cohesion between the interests of various stakeholders – such as clearly defined roles of the board of directors, efficient control mechanisms and presence of systems of monitoring performance – results in long-term gains for the company. Conclusion In conclusion, although there is no specific accepted definition of the term corporate governance, the phenomenon has been described in this report as the process of balancing the interests of a corporation’s stakeholders and offering the mechanisms through which a company can set and achieve its objectives in a responsible way. The relevance of corporate governance to companies can be explained using three theories: stakeholder theory, agency theory, and transaction cost theory. These theories explain the relationship between corporate governance and a company’s stakeholders, the contractual relationships between the owners of a company and the people they assign the role of managing the company, and the attributes of the people who manage companies respectively. Basically, these theories indicate that there is need to balance the interests of company stakeholders, remunerate employees so that they can work to make profits for the company, and to have controls so as to tame opportunistic tendencies by some stakeholders of a company. The report has also discussed three benefits of corporate governance: the benefits that arise from balancing the interests of different stakeholders of a corporation, increased accountability and transparency, and clarification of the roles of key stakeholders. Works Cited Balachandran V. and V. Chandrasekaran. Corporate Governance, Ethics and Social Responsibility. New Delhi: PHI Private Limited, 2011. Du Plessis, Jean Jacques, Anil Hargovan and Mirko Bagaric. Principles of Contemporary Corporate Governance. 2nd ed. Port Melbourne: Cambridge University Press, 2011. Fernando, A.C. Corporate Governance: Principles, Policies and Practices. Delhi: Dorling Kindersley (India) Pvt. Ltd., 2006. Fulgence, Samuel E. “Corporate Governance in Tanzania.” Corporate Governance: An International Perspective. Ed. Samuel O. Idowu, Kiymet Tunca Çaliyurt. New York: Springer-Verlag, 2014. 157-186. Harlacher, Dirk. The Governance of Professional Service Firms. Cologne: Springer-Verlag, 2010. Hussain, Saleh. Corporate Governance: Quantity versus Quality – Middle Eastern Perspective. Web. 13 Dec. 2014. OECD. “Corporate Governance”. 13 July 2005. Web. 13 Dec. 2014. Solomon, Jill. Corporate Governance and Accountability. 2nd ed. Chichester: John Wiley & Sons. Stolt, Robert. Corporate Governance in Hong Kong. Norderstedt: Books on Demand, 2009. Read More