Corporate governance theories explain who governs the business and how it has controlled and organized itself to ensure accountability and transparency. Corporate governance theories help us understand how executives, board members, and stakeholders make decisions. Different governance models, including agency theory of corporate governance, stakeholder theory of corporate governance, and stewardship theory of corporate governance, affect corporate policy and strategy. Proper governance promotes ethical decision-making, financial stability, and sustainable business growth.
What is Corporate Governance?
Corporate governance is the mechanism through which businesses are guided and managed. It ensures that the businesses are carried out responsibly and ethically with financial performance and accountability.
Executing such theories of corporate governance helps us to avoid disputes. They specify the rules and management policies. This applies to owners, employees, directors, etc. It also ensures non-biased faculties about decisions and well-rounded business development. Policies that the company must adhere to remain operational.
Corporate Governance is the framework for the rules and procedures that shape a company’s general direction. Corporate Governance is the structure of rules and practices through which a corporation is directed and controlled, Corporate Governance involves balancing the interests with the key stakeholders in a corporation, which includes, its shareholders, management, customers, suppliers, financiers, government and the community. In this way, it further performs the role of framework within which an organisation formulates.
Theories of Corporate Governance
Theories of corporate governance explain the relationship between different stakeholders like shareholders, board of directors, managers, and others. These theories act as frameworks that help organisations design effective governance structures and practices. In today’s world, where ethical conduct and transparency are vital, understanding these theories is essential
Agency Theory
As per agency theory, a direct relationship exists between shareholders (principals) and managers (agents). It implies that agency issues among managers play a role in that a manager will not always put a shareholder loud but will rather be able to agree sometimes and not agree sometimes, which brings us to their other interests. Companies employ performance-based incentives and audits to guarantee that managers pursue shareholder goals and organizational success.
This theory aims to reduce the conflicts between management and ownership. It focuses on executive compensation, management accountability, and financial transparency. Yet lurk within it the distinctions that may prove damaging, for it inherently presumes that managers are perpetually acting out of self-interest, neglecting to recognize the ethical and social obligations of organizations in governance. A critical issue in this approach is balancing power between shareholders and executives.
Stewardship Theory
The stewardship theory believes that managers act as good stewards of the company and put the organization’s interests above their own. It implies that executives are intrinsically driven to act in the interests of shareholders. This theory emphasizes trust, leadership, and a healthy organizational culture as key business growth and sustainability drivers.
According to Agency Theory, managers are at risk, whereas Stewardship Theory sees managers as partners. This prompts collaboration by executives and stakeholders to make decisions together. However it does not consider room for conflict between management and shareholders. It also assumes that every manager in corporate governance acts ethically, which is not guaranteed.
Stakeholder Theory
As per the Stakeholder Theory, businesses must account for all stakeholders, not just shareholders. It includes employees, customers, suppliers, and the environment. Following this theory, firms emphasize CSR, ethical decision-making, and sustainable business practices to deliver long-term value for all stakeholders.
It encourages equilibrium between social duty and money equity. It holds businesses accountable to society and makes them profitable. However, this can be difficult for many businesses due to diverse stakeholder interests. In some cases, business decisions that can benefit society directly may conflict with sharing maximization of shareholder wealth. As a result, it is impossible to satisfy all groups equally.
Resource Dependence Theory
Resource dependence theory is a design circle that predicts that businesses need external resources to grow and survive in the market. Companies depend on suppliers, investors, and government policies to keep running. They are responsible for obtaining the necessary resources and building partnerships to help their businesses prosper in an ever-competitive marketplace.
In this theory, organizations concentrate on links and relationships with the experts who can benefit them. Alliances help firms in resource access effectively. This theory is too focused on external factors and misses on internal factors like company culture and leadership. This also assumes that businesses cannot manage external risks properly.
Transaction Cost Theory
Cost efficiency is then used to explain corporate governance via the transaction cost theory. Its attention is on transaction cost minimization through the efficient structuring of governance systems. This theory assists businesses in determining if services can be run more cost-effectively by outsourcing or running things in-house.
This theory allows organizations to sharpen the process of decision-making and contract execution. It focuses on cost-effectiveness and avoids additional costs. However, it ignores ethical and social responsibilities in governance. As it is mostly cost-driven, the business does not aim at stakeholder wellness, which is essential for sustainable business in the long term.
Political Theory
The political theory sees corporate governance as a relationship between firms and government policy. It illustrates how political pressures, politics, and lobbying shape corporate decisions. Corporate lobbying and political contributions shape the political landscape To impact industry rules and regulations that enable corporate profit-making.
This theory ultimately points us to the role of government in corporate governance. It delves into how businesses can adapt to legal frameworks and regulatory changes. But it assumes that companies act based only on political factors. It also ignores internal governance players like leadership, ethics and organizational culture that propel business results.
Corporate Governance Responsibilities
Companies have a number of responsibilities to be considered good corporate governance and to facilitate accountability, transparency, and ethical management. Corporate governance includes not only responsibilities to shareholders and customers, but also to ethical business practices, environmental responsibility, inspection of labor practices, protection of whistleblowers, and treatment of employees.
- Board of Directors: Responsible for corporate policies, financials, and executive leadership. They keep the company operating according to legal and ethical norms. Their choice creates long-term business growth and stability.
- Management Team: Responsibility for putting strategies into action and operational management. They manage day-to-day business operations and make procedures more effective. The company can achieve its goals and remain competitive thanks to its leadership.
- As shareholders, we provide capital and hold management accountable. They vote to influence major business decisions. Investments from them contribute to the financial growth and expansion of the company.
- It will require the development of Regulating Bodies too: The rules are set and compliance is ensured with the rules set for a company. They have a system of business practices that promote fairness. They also protect against fraud and help keep markets functioning.
Importance of Theories of Corporate Governance
Organizational experts, doctors, even high-ranking politicians, need to study corporate governance theories to afford appropriate models of governance to ensure the organizational suffered and fulfilled business needs. They affect policies of companies, the legal environment, and strategies of management that take an organization to success.
- Accountability: Corporate governance emphasizes holding people accountable. The various stakeholders are responsible for monitoring activities. They keep the company on its toes. It ensures that the employees know their roles. They have to deliver tasks based on the company objectives.
- Business frauds: Frauds or business thefts have occurred in several businesses. They are dominant with employee actions. For instance, some employees might employ secret accounting practices. It is most frequently to steal money or hide losses. Corporate governance theories prevent such activities. It installs regulations and accountability. Employees also convey the business values and must report to the management.
- Business infrastructure: Corporate governance theories make a healthy structure of work. The owners and management stay connected. They share company performance and goals. It makes their relationship better. Thus, the management can make more independent decisions with more trust.
- Shareholder interests: Shareholder interests are given importance by theories of corporate governance. The policies are formulated according to their welfare. It results in happy ownership. Shareholders receive good profits and the fulfillment of their aspirations.
- Company functioning: Theories of corporate governance set the foundation for functioning. It facilitates the fulfillment of business functions smoothly. The employees know their duties. They are also responsible for various tasks. It results in less confusion.
Theories of Corporate Governance FAQs
1. What is the main focus of agency theory in corporate governance?
Agency theory focuses on resolving conflicts between shareholders and managers by aligning their interests through monitoring and incentives.
2. How does stakeholder theory differ from shareholder theory?
Stakeholder theory includes a wider group such as employees, customers, and communities, while shareholder theory focuses only on maximizing shareholder value.
3. What is the relevance of stewardship theory in Indian companies?
In many Indian family-run businesses, stewardship theory is evident. Founders and promoters act in the best interests of the firm without needing close supervision.
4. Why is resource dependency theory important in today’s global business?
It helps companies manage their dependence on external parties like regulators and investors, especially in a highly interconnected global economy.
5. How does political theory affect corporate governance laws in India?
India’s Companies Act, CSR mandates, and SEBI guidelines show how government policies shape corporate governance frameworks.
