In this blog, we will look at the top 10 theories of corporate governance and analyze their applicability and importance, especially for organizations in India. Corporate governance is an important branch of management that discusses the way companies are managed and regulated and the responsibility towards the people who hold a stake in any corporate house. As a result, over time there has been a plethora of theories on the practice and principles of corporate governance. They are useful principles that should be adopted to ensure that organizations perform their activities ethically, clearly, and in a manner that is relevant to customers, shareholders, employees, and society in general.
What is the Corporate Governance?
Corporate governance can be defined as the manner in which corporations are managed, controlled, and held accountable. It includes the system of policies, procedures, and practices that can not only maintain but also promote full disclosure, fairness, and corporate governance in an organization. Corporate governance involves the relationship between a firm’s managers, its board of directors, shareholders, and many other parties.
1. Board Structure and Responsibilities: Part two addresses the characteristics of the board of directors, including the duties of the board of directors, independent directors and committees.
2. Shareholder Rights: Protecting and ensuring the independent and proper exercise of their powers by shareholders.
3. Transparency: Ensuring that relevant information about financial performance and governance issues is disclosed at the appropriate time.
4. Accountability: How management can be held accountable and made accountable for their actions or decisions in the organization.
5. Ethics and Integrity: Introducing acceptable standards of behaviour in the organization considering laws and regulations.
What are the Top 10 Theories of Corporate Governance in India?
1. Agency Theory
2. Stakeholder Theory
3. Stewardship Theory
4. Resource Dependency Theory
5. Transaction Cost Theory
6. Political Theory
7. Ethical Theory
8. Social Contract Theory
9. Behavioral Theory
10. Legitimacy Theory
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1. Agency Theory
Agency theory studies the principal and agent environment where problems (agency costs) arise due to a mismatch between managerial and shareholder priorities.
1. Agency problem: Assumption of managers having different objectives with shareholders.
2. Asymmetric information: Often, it is observed that managers have better access to information than shareholders.
3. Goal alignment: Promoting schemes that bring the interests of employees and the company on equal footing, such as access to a large portion of stock through ESOP.
4. Monitoring: Measures, namely independent directors, audits, and jurisdiction.
2. Stakeholder Theory
Stakeholder theory is one of the concepts of corporate governance that goes beyond the idea of shareholder value and identifies stakeholders as people and organizations that can influence a firm. The theory emphasizes the fact that organizations owe something to various stakeholders rather than focusing only on shareholders’ profits.
1. Shareholders: Members who provide funds for the business and expect benefits from it.
2. Employees: People who provide their talents and ability to work.
3. Customers: Business buyers who look forward to receiving good quality products and services.
4. Suppliers: Related parties who provide products and services.
5. Community and society: It includes all other large interest groups that are affected by the company’s environmental, social and economic performance.
6. Government and regulators: Each body is responsible for the enforcement of the country’s laws and/or policies.
3. Stewardship Theory
Definition: According to Stewardship Theory, managers, rather than being selfish agents, are stewards of the company by nature. Their actions are always in the interest of the totality of the company and shareholders, especially when most employees are motivated by trust, loyalty, and commitment.
Managers are usually self-motivated to accomplish the organization’s goals.
The element of trust and delegation of authority replaces close supervision.
Focus on continuous improvement of the asset base and creation of sustainable enterprise value.
Enhances partnership between management and shareholder pairs.
4. Resource Dependency Theory
When it is applied to corporate governance, resource dependency theory (RDT) adjusts the idea of physical dependency to suggest that organizations are interdependent and require external resources. The theory states that the efficiency and effectiveness of an organization are a result of how an organization responds to these dependencies with other entities or organizations, such as suppliers, customers, regulators, and other relevant organizations.
1. Boards as resources: Conflict of interest is the ultimate advantage of directors, where they introduce expertise and contacts into the organization.
2. Access to networks: Outsourcing ensures that the business attracts funding for its operations, relevant technologies, and market information.
3. Legitimacy: An effectively designed board improves reputation and credibility.
4. Reducing uncertainty: With strategic relationships these risks are avoided or greatly reduced in a constantly changing environment.
5. Transaction Cost Theory
Transaction cost theory is an economic theory that looks at how organizations can minimize the cost of financial transactions. Ronald Coase formulated this theory. However, Oliver E. Williamson added more ideas to it. This theory looks at the proposition that every business transaction inside or outside the organization has some cost and that appropriate structures of governance are necessary to minimize the cost.
1. Transaction costs: These would include the cost of search, negotiation, and policing.
2. Markets versus hierarchies: Executives and managers in organizations choose to transact through markets or internal organizations depending on the cost.
3. Uncertainty and opportunism: High uncertainty is associated with increased costs and opportunistic behaviour.
4. Frequency and asset specificity: Transactions that occur regularly and/or are typically handled in-house.
6. Political Theory
Politics in corporate governance covers the aspect of how the political system, laws and regulations affect the operations of firms. In India, it is seen as follows:
1. Regulatory frameworks: Regulatory bodies that affect corporate governance include SEBI, RBI and MCA; regulations including the Companies Act, 2013 and SEBI’s LODR [9].
2. Government policies: Legal requirements affect organizational activities other than profit, for example, through corporate social responsibility mandates.
3. Political stability: The implementation of proper corporate governance practices requires stable government foundations, just as it does for company reforms.
4. Public expectations: Businesses must change to adapt to society’s expectations and requirements, for example, integrity and disclosure.
5. State ownership: The government plays a key role in the management of state-owned enterprises, but politics cannot be prevented from affecting the governance of these organizations.
6. Corporate influence on politics: They suggest that lobbying and campaign finance are ways in which corporations can change policy decisions.
7. International influence: Multinationalism and the rules and regulations created in the international business system influence corporate governance in India.
7. Ethical Theory
Ethical theory in corporate governance declares the principles that organizational actions should be moral, correct, fair and balanced. It supports the call for managerial action that goes beyond financial profitability and takes into account shareholder welfare and the well-being of the community.
1. Honesty and integrity: This is done by setting a high ethical tone by management by exercising personal integrity and refraining from unethical behaviour.
2. Accountability: Being accountable for the decisions taken by the firm and being able to make decisions that are right for the stakeholders.
3. Fairness: Fair dealings with all stakeholders.
4. Corporate Social Responsibility (CSR): Supporting social needs and improving the environmental outlook of a region.
5. Long-term perspective: To leverage sustainable improvement rather than fixing your sight on the present and currently sluggish improvements.
6. Leadership and Ethical Culture: The role of leaders in the ethical culture of the organization.
8. Social Contract Theory
The social contract theory in corporate governance holds that corporations have an implicit social responsibility. They need to conduct their operations in a manner that is acceptable and fair to society. In addition, the firm needs to be socially beneficial, not just helpful to its shareholders.
1. Mutual benefit: Corporations must provide value to shareholders as well as employees, customers and the general public.
2. Corporate responsibility: Businesses must fulfil ethical, legal and environmental responsibilities.
3. Stakeholder focus: Managers must view the organization from the perspective of all stakeholders, not just shareholders.
4. Accountability: Both parties must be honest with each other.
5. Long-term commitment: It is important to incorporate elements of sustainable management and development into companies’ policies.
9. Behavioral Theory
Behavioural theory in corporate governance deals with the way people behave and how perceptions, heuristics and emotions affect decision-making and governance. It understands that people are involved and are not always making objective decisions based on facts but rather involving emotions, past experiences and social influences.
1. Cognitive biases: These are the possibilities: that managers may make selective decisions based on favourable outcomes or due to excessive confidence.
2. Group dynamics: This is particularly the case as the boardrooms of most family businesses are prone to groupthink and, therefore, poor decision-making.
3. Emotional factors: This means that things like fear or ego may interfere with the decision-making process.
4. Risk aversion: Management decisions may be influenced by risk aversion which is a strategic factor.
5. Information processing: Cognitive impairment leads to reduced information processing capacity; decisions taken may be influenced by inadequate information.
10. Legitimacy Theory
Legitimacy theory implies that organizations must act according to certain universally accepted standards and respond to perceived social demands in order to be recognized and accepted as legitimate. Companies’ actions must take into account several stakeholder groups in order to obtain a license to operate in society.
1. Social acceptance: People expect organizations to behave in ways that are socially acceptable (such as compliance with ethical and environmental regulations).
2. Stakeholder expectations: To comply with the legal requirement of legitimacy, ensuring that it meets the various interests of various stakeholders.
3. CSR: Corporate social responsibility keeps organizations in check with regard to social expectations and requirements; this is due to the fact that CSR is mandatory for some organizations in India.
4. Transparency: Transparent methods and processes are necessary for the so-called legal tender feature of reporting.
5. Adaptability: Organizations have to adapt to new trends, social needs, and legal requirements.
Conclusion
The theories of corporate governance present a coherent paradigm that explains the way in which business enterprises are managed and supervised. Whichever theoretical framework one uses, agency theory, stakeholder theory, stewardship theory or legitimacy theory, each offers a unique perspective on shareholder-manager relationships and relationships with other stakeholders.
In the Indian framework, corporate governance is important to promote corporate transparency and legal compliance as well as to prevent fraudulent practices due to the dynamic environmental structure. Theories such as legitimacy theory point to CSR, sustainability and proper legal compliance which have become even more important for organizations.
FAQs
Q1. What is meant by corporate governance?
Corporate governance can be defined as the mechanism used in the management and supervision of companies to prevent undesirable activities of their managers. It also aims to achieve equitable relationships between business stakeholders in efforts to improve sustainable performance and sustainability.
Q2. What are the 4 P’s of corporate governance?
The 4 P’s of Corporate Governance are:
People: The stakeholders involved in the company, including the board of directors and management.
Purpose: Primary and Secondary Organisational Goals/ Corporate objectives/mission.
Process: The business management structures and formalized methods of decision-making and control.
Performance: Evaluating the produced results with a view to accomplishing the goals of the strategy.
Q3. What are the four models of corporate governance?
There are four corporate governance models:
Anglo-American: Emphasizes the interests of customers, shareholders, and disclosure.
German: Has a two-tier board structure with ordinary employees and shareholders.
Japanese: Emphasizes the nature of the organization to maintain long-term relationships with stakeholders.
Indian: A liberal one that sits nicely between compliance, CSR, and shareholder demands.
Q4. What is an example of governance?
An example of governance is how the board of directors of a particular company monitors management so that it can best serve shareholders and other stakeholders. For example, a specific firm may have a separate committee of the board that works to ensure that the organization’s disclosure of financial information complies with regulations, for example, to maintain principles of integrity and accountability in the organization.
Q5. What are corporate governance terms and definitions?
Corporate governance refers to the system of overseeing a company through rules, procedures, and business management systems. It is the process of satisfying the various stakeholders of a firm; this includes shareholders, managers, customers, suppliers, the public, etc.
Q6. What are the two types of government?
There are two main types of government:
Democracy: Conceptually, the three political powers are vested in lower sovereignty, under which voters choose their leaders to make decisions that are in their best interests.
Autocracy: One in which decision-making remains in the hands of a particular person or a close group of people, giving very little political freedom to the people as a whole.
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