the theory practice of corporate governance n.
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The Theory & Practice of Corporate Governance . Chapter No 2. What is a Corporate?.

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what is a corporate
What is a Corporate?

“ By a company is meant an association of many persons, who contribute money or money's worth to a common stock and invest it in some trade or business, and who share profit and loss (as the case may be) arising there from. The common stocks so contributed is denoted in money and is the capital of the company. The persons who contributed it, or to whom it belongs, are members. The proportion of capital to which each member is entitled is his share. Shares are always transferable, although the right to transfer them is often more or less restricted.” Justice Lindlay

characteristics of a corporation
Characteristics of a Corporation
  • Incorporated Association
  • Artificial Legal Existence
  • Perpetual Existence
  • Common Seal
  • Extensive Membership
  • Separation of Management from Ownership
  • Limited Liability
  • Transferability of Shares
the concept of governance
The Concept of Governance

Governance means the process of decision-making and the process by which decisions are implemented (or not implement).

theoretical basis of corporate governance
Theoretical Basis of Corporate Governance
  • Agency Theory
  • Stewardship Theory
  • Stakeholder Theory
  • Sociological Theory
agency theory
Agency Theory
  • Owners (shareholders) / Principals
  • Management / Agents
  • Agency Problem
  • Agency Cost
  • Agency Loss
  • Problems with The Agency Theory
  • Mechanisms to Reduce Agency Cost
  • Fair & Accurate Financial Disclosures
  • Efficient & Independent Board of Directors
stewardship theory
Stewardship Theory
  • Stewards whose motives are aligned with the objectives of their principals.
  • A steward’s behavior will not depart from the interests of his / her organization.
  • Control can be potentially counter productive, because it undermines the pro- organizational behavior of the steward, by lowering his / her motivation.

“Stewardship refers to the responsibility of the board to oversee the conduct of the business and to supervise management which is responsible for the day-to-day conduct of the business. In addition, as stewards of the business, the directors function as the catch-all to ensure no issue affecting the business and affairs of the company falls between cracks.” Canadian Guidelines

agency theory vs stewardship theory a behavioral differences
Agency Theory

Manager acts as agents

Governance approach is materialistic

Behavior pattern is individualistic, opportunistic & self-serving

Managers are motivated by their own objectives

Interests of the managers and principals differ

The role of the management is to monitor and control

Owners’ attitude is to avoid risks

Principal-Manager relationship is based on control

Stewardship Theory

Managers act as stewards

Governance approach is sociological & psychological

Behavior pattern is collectivistic, pro-organizational & trustworthy

Managers are motivated by the principal’s objectives

Interests of the managers and principals converge

The role of the management is to facilitate and empower

Owners’ attitude is to take risks

Principal-Manager relationship is based on trust

Agency Theory Vs Stewardship Theory A) Behavioral Differences
b psychological mechanism
Agency Theory

Motivation revolves around

Lower order needs

Extrinsic needs

Social comparison is between compatriots

There is little attachment to the company

The power rests with the institution

Stewardship Theory

Motivation revolves around

Higher order needs

Intrinsic needs

Social comparison is between principals

There is great attachment to the company

The power rests with the personnel

B) Psychological Mechanism
c situational mechanisms
Agency Theory

Management philosophy is control oriented

To deal with increasing uncertainty & risk, the theory advocates exercise of

Greater controls

More supervisions

Risk orientation is done through a system of control

Time frame is short term

The objective is cost control

Cultural differences revolve around


Large power distance

Stewardship Theory

Management philosophy is involvement oriented

To deal with increasing uncertainty & risk, the theory advocates exercise of

Greater training & empowering people

Making jobs more challenging & motivating

Risk orientation is done through trust

Time frame is long term

The objective is improving performance

Cultural differences revolve around


Small power distance

C) Situational Mechanisms
stakeholder theory
Stakeholder Theory

Stakeholders = Shareholder Group


Non-shareholder Group





Society at Large

criticism of the stakeholder theory
Criticism of the Stakeholder Theory
  • Not applicable in practice by Corporation
  • Comparatively little empirical evidence
  • Difficulty of defining the concept
  • Leading to chaos
  • Opening doors to corruption
shareholder vs stakeholder approaches
Shareholder vs Stakeholder Approaches


  • Obeying the law
  • Maximizing shareholder’s wealth
  • Assumption – Perfect Competition


  • Board & Management have responsibilities to parties other than shareholders.
  • Profit maximization subject to the constraint of respecting obligations owed to such stakeholders.
sociological theory
Sociological Theory
  • Power & Wealth Distribution
  • Board Composition
  • Financial Reporting
  • Disclosure
  • Auditing
  • Equity & Fairness
why corporate governance
Why Corporate Governance?
  • Companies need to be governed as well as managed
  • The board of directors is central and its structure & processes are fundamental
  • The board’s relationship with the company’s shareholders, regulators, auditors, top management and other legitimate stakeholders
corporate governance system
Corporate Governance System



Interaction Between the Management And the Board

corporate governance systems
Corporate Governance Systems
  • The Anglo-American Model – Unitary Board Model
  • The German Model – Two-Tier Model
  • The Japanese Model – Business Network Model
  • The Subcontinent Model
the anglo american model unitary board model anglo saxon
The Anglo-American ModelUnitary Board Model (Anglo-Saxon)


Board of Directors (Supervisors)


Appoints & supervises

Officers (Managers)


Monitors & Regulates

Lien on


Regulatory/ Legal system



Stake in

the anglo american model unitary board model anglo saxon1
The Anglo-American ModelUnitary Board Model (Anglo-Saxon)

Major Features

  • A single board comprising both executive and non executive directors in varying proportions.
  • The ownership of companies is more or less equally divided between individual shareholders and institutional shareholders.
  • Directors are rarely independent of management.
  • Typically managed by professional managers who have negligible ownership stakes.
  • There is fairly clear separation of ownership and management.
  • Most institutional investors are reluctant activists.
  • The disclosure norms are comprehensive, the rules against insider trading strict, & the penalties for price manipulations stiff, all of which provide adequate protection to the small shareholders and promote general market liquidity.
the german model two tier board model
The German ModelTwo-Tier Board Model

Appoint 50%

Appoint 50%

Supervisory Board

Appoints & Supervises

Employees & Labor Unions

Management Board (Including Labor Relations Officer)





the german model two tier board model1
The German Model -Two-Tier Board Model

Main Features

  • Corporate Governance is exercised through boards: Supervisory & Management Boards
  • The upper board supervises the executive board on behalf of stakeholders.
  • Corporate Governance approach is typically societal-oriented (Continental European approach).
  • Shareholders own the company, they do not entirely dictate the governance mechanism.
  • 50% of members of supervisory board is elected by the shareholders & remaining 50% is appointed by labor unions
  • The supervisory board appoints and monitors the management board.
  • The management board independently conducts the day-to-day operations of the company but reports to the supervisory board.
the japanese model business network model
The Japanese Model – Business Network Model

Provides Managers, Monitors & Acts in Emergences


Supervisory Board (Including President)

Provides Managers

Ratifies the President’s decisions




Main Bank

Executive Management (Primarily Board of Directors)


Provides Loans




the japanese model business network model1
The Japanese Model – Business Network Model

Main Features

  • Boards tend to be large, predominantly executive and often ritualistic.
  • The reality of power in the enterprise lies in the relationship between top management in the companies (keiretsu network or Korean chaebol)
  • The financial institution plays a crucial role in governance.
  • The shareholders and the main bank together appoint the board of directors and the president.
  • The president who consults both the supervisory board and the executive management.
common features in the german and japanese model
Common Features in the German and Japanese Model
  • Banks and financial institutions have substantial stakes in the equity capital of companies.
  • Institutional investors in both the countries view themselves as long term investors. They play a fairly active role in corporate managements.
  • The disclosure norms are not very stringent, checks on insider trading are not very comprehensive and effective, and emphasis on liquidity is not high.
  • There is hardly any system of corporate control in these countries; mergers and take-overs are rare occurrences.
subcontinent model of governance
Subcontinent Model of Governance
  • Subcontinent corporates are governed by the Company’s Act of 1956 in the case of India & by the Company’s Ordinance of 1984 in the case of Pakistan that follows more or less the UK model
  • The pattern of companies in private sector is mostly that of closely held or dominated by a founder, his family and associates. A similarity that it shares with the German & the Japanese models.
subcontinent model of governance1
Subcontinent Model of Governance

External Environment

Government Regulations, Policies, Guidelines etc.

Corporate Culture, Structure Characteristics, Influences

Internal Environment Company Vision; Mission, Policies, Norms


Internal Board of Stakeholders Directors

Depositors, Borrowers, Customers and Other Stakeholders

Company’s Act SEC Stock Exchanges


Proper Governance Shareholder Value

Corporate Governance Outcome / Benefits to Society


Investor Protection Concern for Customer

Healthy Corporate Sector Development

obligation to society at large
National Interest

Political Non-Alignment

Legal Complication

Rule of Law

Honest & Ethical Conduct

Corporate Citizenship

Ethical Behavior

Social Concern

Corporate Social Responsibility


Healthy & Safe Environment




Effectiveness & Efficiency

Timely Response

Corporations Should Uphold The Fair Name Of The Country

Obligation To Society At Large
obligation to investors
Obligation To Investors
  • Towards Shareholders
  • Measures Promoting Transparency & Informed Shareholder Participation
  • Transparency
  • Financial Reporting & Records
obligation to employees
Obligation To Employees
  • Fair Employment Practices
  • Equal Opportunities Employer
  • Encouraging Whistle Blowing
  • Humane Treatment
  • Participation
  • Empowerment
  • Equity & Inclusiveness
  • Participative & Collaborative Environment
obligation to customers
Obligation To Customers
  • Quality Of Products & Services
  • Products At Affordable Prices
  • Unwavering Commitment To Customer Satisfaction
managerial obligations
Managerial Obligations
  • Protecting Company’s Assets
  • Behavior Towards Government Agencies
  • Control
  • Consensus-Oriented
  • Gifts & Donations
  • Role & Responsibilities of Corporate Board & Directors
  • Direction & Management Must Be Distinguished
  • Managing & Whole-Time Directors