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Unformatted text preview: Corporate Governance
Lec 2 The CG Framework
The 2 Corporate Governance – An Introduction Corporate – related with corporations
Governance derived from Latin ‘gubernare’ meaning to ‘steer’
The way in which companies are directed and controlled (Cadbury Report 1992)
Recent examples of massive collapses resulting from weak systems of CG have highlighted the need to improve and reform CG at international level.
3 Corporate Governance – An Introduction Some recent reforms:
• USA issued SarbaneOxley Act (2002)
Higgs and Smith Reports (2003) UK
SECP guidelines in Pakistan
OECD guidelines in European continent. 4 Corporate Governance – An Introduction There are different perspectives of CG and the same is evident from the definitions as well.
One approach of CG adopts a narrow view, where CG is restricted to the relationship b/w a company and its shareholders.
In an other approach, CG has broader spectrum beyond shareholders extending that to stakeholders such as employees, customers, suppliers, governments etc.
5 Corporate Governance – An Introduction
Some Definitions of CG are:
“the process of supervision and control intended to ensure that the company’s management acts in accordance with the interests of shareholders (Parkinson 1994)
“the governance of an enterprise is the sum of those activities that makeup the internal regulation of the business in compliance with the obligations placed on the firm by legislation, ownership and control. It incorporates the trusteeship of assets, their management and their deployment (Cannon 1994) 6 Corporate Governance – An Introduction
Some Definitions of CG are (Contd):
According to Solomon & Solomon (2004: 14) CG is “the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity.” This definition perceives that companies can maximize value creation over the long term by discharging their accountability to all of their stakeholders and by optimizing their system of CG
7 Corporate Governance – An Introduction
The same outcome was identified by different independent researches such as the reports of UK Investment Institute of the Higgs report found that:
Companies that demonstrate a commitment to a broad range of stakeholders are likely to show better management skills and increase in accountability can maximise the sustainable wealth creation. Body shop, Tesco, Patagonia
8 Corporate Governance – Theoretical Frameworks A number of different theoretical frameworks have evolved to explain and analyze CG such as:
The Agency Theory (Finance and Economics)
Transaction Cost Theory (Economics and Organizational Theory)
Stakeholder Theory (Socialoriented perspective) 9 Corporate Governance – Theoretical Frameworks
The Agency Theory: Owners (shareholders) delegate the running of the company to management Owners: Principals Management: Agents Their relationship is the agency theory. The problem is that sometime the agents take decisions which are not in the best interests of the principals. Due to managers egoism or personal objectives leading to short term profits but ignoring the long term sustainable profit maximisation or in other words ignoring the long term consequences.
10 Corporate Governance – Theoretical Frameworks
The Agency Theory (Cont’d): Same is in case of risk sharing Again the monitoring of agents by principals is a difficult and expensive task. Usually contract (agreements) are performed to solve this problem. As well as the voting power of the shareholders and their power for “Takeover” vote is useful for the balancing of powers.
11 Corporate Governance – Theoretical Frameworks
Transaction Cost Theory Talks about cost of transactions for a company and its relationship with the management’s opportunism Imagine – Vertical integration reduces the costs of the company. Oil Cos from exploration to customer However, managers have bounded rationality. Managers try to organize the transactions in their best interests. Transaction cost theory suggests that shareholders should have control (influence) in the decision making and managers should pursue the best interests of the shareholders rather than their own personal interests 12
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Stakeholders Theory Freeman (1984) proposed that corporate accountability to a broader range of stakeholders.
• Today you can see availability of Co information, annual reports on different medium such as newspapers, websites The role of companies in societies has received increasing attention over time, with their impacts on employees, the environment, local communities as well their own shareholders.
A basic thing is that Cos are now so large and they have impact on the society. Imagine even in KPK the role of sugar mills or PTC, Lakson on Tobacco growers!!!
Some BS!! 13
13 Corporate Governance – Theoretical Frameworks
Stakeholders Theory (Cont’d) linked to stakeholders theory is the concept of corporate Social Responsibility (CSR) as well. While researches have found a positive relationship b/w revenues and CSR.
However, it is very difficult to balance the interests of different stakeholders.
However, it is expected of today’s enterprises that they will have to cater to the needs and wants of the different stakeholders rather than a single stakeholder in term of shareholders.
Look at Apple’s initiative or Dell and HP initiatives, Tesco etc 14
14 Corporate Governance – Theoretical Frameworks
To Conclude we can say that: Ignoring the stakeholders can result in corporate failure while concern for stakeholders attracts investors in the current times. And to survive companies has to look beyond share holders to a broader range of stakeholders as well as companies should have more accountability (not mere financial but all encompassing) and more control on its internal processes. 15
15 Essential Principles of CG
Transparency Independence Accountability Responsibility Fairness
Social responsibility 16 Is there some global uniformity Converging Diverging 17 Corporate Governance – Tasks for Next Week Divide into groups of five and select companies from the list and prepare presentation, that is to be presented in the first class next week. It carries marks and participation is must.
• Enron, Tyco, Union Carbide, Satyam Computers, Adelphia, WorldCom, Global Crossing, Madoff 18
18 References Solomon, J. and Solomon, A. (2004). Corporate Governance and Accountability. Chichester: John Wiley & Sons – PP 130 19
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This note was uploaded on 03/07/2012 for the course FINANCE 245 taught by Professor Hameed during the Spring '12 term at IMSciences.
- Spring '12