Corporate Governance Theories

Lecture 2 (1) Asst. Prof. Saroj Ghimire

Theories of Corporate Governance

Agency theory: The development of agency theory is often traced back to the Berle and Means (1932), although some writers suggest that one can go back to Adam Smith in 1775 and the influential book The Wealth

of Nations.

Agency

Agency is a contract under which one or more persons (the principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent.

The problem of agency in Corporate governance

The agency relationship can be problem if agent does not work for the best interest od principles. In Company, the board of directors are considers to be the agent of the shareholder. The shareholders who is the owner, or principal of the company, delegates day to day decision making in the company to the directors, who are shareholders agent.

This separation of ownership and control has led to the notorious problem. The problem is the agents do not necessarily make decisions in the best interest of the principal. They prefer pursuing the highest bonuses and maximise their own perceived interets rather than maximisation of the their long term wealth. They see more short term benefits and gaining quick profit.

They are said to be more tempted to supplement their salaries with many prerequisites (holidays, office equipment and others). This led shareholder to control the management of the company. This opened the door for the corporate governance. Therefore the agency theory of corporate governance emphasises on the balancing power between the board and shareholders.

The shareholder has also the power to control over the management by: Voting, Remuneration contracts Annual report, Their appointment of board By divesting their share (Huntingdon life science)

Stakeholder theory
Developed since 1970s. Freeman postulates the theory of corporate accountability to a broad range of shareholders. Companies acts have affected employees, local community and environment and even to their shareholders there fore their accountability is expected.