Corporate Governance
Lecture 1 Introduction to/Theories underlying corporate governance
(Chapter 2)
Scandals, Frauds and collapses
The Enron case highlights the overriding need for integrity in business
Directors: act with integrity and honesty
External audit firm (Arthur Andersen): be able to ask searching questions of the
directors without holding back for fear of offending a lucrative client.
Enron also highlights the need for independent non-executive directors who are
experienced enough to be able to ask searching questions in board and committee meetings
to try to ensure that the business is operated appropriately
The Theranos case highlights the importance of ownership structure and monitoring from
boards
Theranos had a dual-class shareholding structure where Holmes had 100 votes for
every one vote of other shareholders, and she retained total control of the
composition of the company’s board
The board was not fillet with the types of professionals that we would expect
1. Lack of medical professionals and financial professionals and others
2. Filled with politicians and military advisers
Two different definitions of Corporate Governance
1. Deals with the ways in which suppliers of finance to corporations assure themselves
of getting a return on their investment
2. Refers to a set of relationships between a company’s board, its shareholders, and
other stakeholders
Why Corporate Governance?
Encourage transparency and accountability by putting in a place a system of internal
controls
Ensure good decision-making good management, good investments; create checks &
balances and prevent abuse of power
Better corporate performance, economic efficiency, and social welfare
More access to capital, lower cost of capital
1
,Three theories underlying corporate governance
1. Agency Theory
There are different forms of business
1. Sole proprietorship: an unincorporated business that has just one owner who pays
personal income tax on profits earned from the business.
2. Partnership: A formal arrangement by two or more parties to manage and operate a
business and share its profits
3. Corporation: A legal entity that is separate and distinct form its owners.
Owners (shareholders) do not directly manage the business
Owners elect board of directors at annual shareholders meeting
Board hires and monitors CEO and other executives who run the
business
What is the Agency theory?
Organizations are characterized by one party, the principal, who delegates work to another
party, the agent.
The parties agree to join and do business, but conflicts of interests can arise
managers can misuse their power by acting in their own interest at the expense of
owners Agency problems arise.
Furthermore, there is also the problem of information asymmetry whereby the
principal and the agent have access to different levels of information; in practice, this
means that the principal is at a disadvantage because the agent will have more
information
To avoid the agency problems, the owners need to:
1. Monitor the managers
2. Find ways to align interests
Since a corporation has stakeholders other than just
owners and managers, agency problems also arise
between all these stakeholders
2
, 2.Stakeholder theory
Stakeholder theory takes account the interest of a wider group of constituents rather than
that of shareholders
The term ‘stakeholder’ can encompass any individual or group on which the activities
of the company have an impact:
- Employees
- Customers
- Suppliers
- Creditors
- Government
- Local community
Shareholders and stakeholder may favour different corporate governance structures and
also monitoring mechanisms:
1. Angelo-American model: emphasis on shareholder value and a board comprised
totally of executive and non-executive directors elected by shareholders
2. German model: certain stakeholder groups, such as employees, have a right
enshrined in law for their representatives to sit on the supervisory board alongside
the directors.
3. Institutional theory looks at the institutional environment (systems, norms, beliefs,
values) that shape behaviour of individuals/stakeholders)
3
Lecture 1 Introduction to/Theories underlying corporate governance
(Chapter 2)
Scandals, Frauds and collapses
The Enron case highlights the overriding need for integrity in business
Directors: act with integrity and honesty
External audit firm (Arthur Andersen): be able to ask searching questions of the
directors without holding back for fear of offending a lucrative client.
Enron also highlights the need for independent non-executive directors who are
experienced enough to be able to ask searching questions in board and committee meetings
to try to ensure that the business is operated appropriately
The Theranos case highlights the importance of ownership structure and monitoring from
boards
Theranos had a dual-class shareholding structure where Holmes had 100 votes for
every one vote of other shareholders, and she retained total control of the
composition of the company’s board
The board was not fillet with the types of professionals that we would expect
1. Lack of medical professionals and financial professionals and others
2. Filled with politicians and military advisers
Two different definitions of Corporate Governance
1. Deals with the ways in which suppliers of finance to corporations assure themselves
of getting a return on their investment
2. Refers to a set of relationships between a company’s board, its shareholders, and
other stakeholders
Why Corporate Governance?
Encourage transparency and accountability by putting in a place a system of internal
controls
Ensure good decision-making good management, good investments; create checks &
balances and prevent abuse of power
Better corporate performance, economic efficiency, and social welfare
More access to capital, lower cost of capital
1
,Three theories underlying corporate governance
1. Agency Theory
There are different forms of business
1. Sole proprietorship: an unincorporated business that has just one owner who pays
personal income tax on profits earned from the business.
2. Partnership: A formal arrangement by two or more parties to manage and operate a
business and share its profits
3. Corporation: A legal entity that is separate and distinct form its owners.
Owners (shareholders) do not directly manage the business
Owners elect board of directors at annual shareholders meeting
Board hires and monitors CEO and other executives who run the
business
What is the Agency theory?
Organizations are characterized by one party, the principal, who delegates work to another
party, the agent.
The parties agree to join and do business, but conflicts of interests can arise
managers can misuse their power by acting in their own interest at the expense of
owners Agency problems arise.
Furthermore, there is also the problem of information asymmetry whereby the
principal and the agent have access to different levels of information; in practice, this
means that the principal is at a disadvantage because the agent will have more
information
To avoid the agency problems, the owners need to:
1. Monitor the managers
2. Find ways to align interests
Since a corporation has stakeholders other than just
owners and managers, agency problems also arise
between all these stakeholders
2
, 2.Stakeholder theory
Stakeholder theory takes account the interest of a wider group of constituents rather than
that of shareholders
The term ‘stakeholder’ can encompass any individual or group on which the activities
of the company have an impact:
- Employees
- Customers
- Suppliers
- Creditors
- Government
- Local community
Shareholders and stakeholder may favour different corporate governance structures and
also monitoring mechanisms:
1. Angelo-American model: emphasis on shareholder value and a board comprised
totally of executive and non-executive directors elected by shareholders
2. German model: certain stakeholder groups, such as employees, have a right
enshrined in law for their representatives to sit on the supervisory board alongside
the directors.
3. Institutional theory looks at the institutional environment (systems, norms, beliefs,
values) that shape behaviour of individuals/stakeholders)
3
