Corporate Governance

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Corporate Governance Concept

Corporate governance is not a very new issue in society because the issues it addresses have been there since ancient times. Williamson (1985) and Zingales (1998) suggest that this mechanism is like a guidebook of how the profits generated by a company will be split among stakeholders and managers. We may also look at this concept through our understanding of ‘governance’. Governance determines and examines the performance of the top managers when it comes to issues of administering their duties as stated out in contracts (Garvey, 1994).

John (1998) suggests that this mechanism enables stakeholders to control the way management acts. This enables the interests of these stakeholders to be protected. This very same view is expressed by Hart (1995) who writes that corporate governance arises when there are two issues in a company. First there is conflict between stakeholder’s interests or as he terms it ‘agency problems’ and secondly these problems cannot be dealt with through a contract.

With the analysis of all these definitions, the conclusion was drawn that there are some common characteristics. These include; the conflicting interest of stakeholders and consensus on the knowledge that this corporate governance problem cannot be solved fully since there is utmost uncertainty. There is need for mechanisms that will help get rid of the corporate problems.

Determinants of Corporate Governance Problem (agency problems)

In some cases managers do not easily get along with stakeholders; this is the major cause of agency problems. The control and ownership pull the company into two different directions. According to Jensen et al., (1976) agency problems arise because a company is a legal structure right from its inception, when it was formed by the law. A company is a legal entity and thus is entitled to enter into legal agreements. This thus affects the interest of all stakeholders. These legal contracts have to be signed in the best interest of stakeholders. Debt may help in overcoming the issue of agency problems especially when it is dealing with equity issues. This however will bring about a whole new agency problem.

McColgan (2001) was able to extend Jensen and Meckling’s study; he tried to cover the difference in the interest of stakeholders and managers on a firm by firm basis. That agency problems are not the same in all firms; they differ according to structure, size, industry and culture.

Corporate governance problems do not come about only when stakeholders conflict with the managerial team, but also when the agency problem gives rise to transaction costs that cannot be dealt with in contracts (Hart, 1995).

Corporate Governance Regulations and Interested Parties

In the United States of America these sources have been attributed to be; security laws, corporate laws, best practices and listing standards. This applies to developed countries firms (Rezaee, 2009, p. 44). These laws vary in different states but the common law applied is the legality of a firm. A firm is distinguished from any person according to any state and it may contract as a legal entity and thus may also be sued. Companies are also governed by common law. These laws state how companies may be governed.

Moreover companies may also have their own legally binding law that governs their employees and clearly shows the extent of power of decision makers. Their powers may be limited at any time. They may also be allowed to exercise authority in some situations that encompass more than their position requires of them. These laws are constituted in countries year in year out. The U.S in 1977 modified the Foreign Corrupt Practices Act, The U.K, in 2010 that made bribery illicit, consented on the Bribery Act, in 2002 that also made bribery unlawful. The U.S consented to the passing of the Sarbanes- Oxley Act which led to establishment of subsequent laws to govern scandals in the corporate world. An example of this is the Public Company Accounting Oversight Board (PCAOB) that was put in place to govern auditors.

There are various parties that are affected by corporate governance directly such as shareholders, management, Board of Directors, employees, suppliers, regulators, banks, customers, the environment and the community within the business. Other parties affect corporate governance indirectly and they include; advisors, rating firms, auditors, customers, suppliers, community, government agencies, and proxy advisors. We should not dismiss the parties that affect corporate governance indirectly because they impact it substantially. It is almost as if they are a part of the voluntary regulators of corporate governance (Rose, 2007).

Various Stakeholders’ Interest

To be able to understand the conflict between stakeholders, we need to better understand the interest of each individual stakeholder first. All parties discussed above each have their own separate interest in the firm and each is as equally important. Investors have risked their own money into the business and they expect a return on these investments no matter the amount; employees, managers and directors on the other hand expect a remuneration of any sort for the time they have put into the business. Lenders expect a return on the money loaned out along with an additional interest after a specified duration. Equity investors expect dividends or capital gains at the end of each financial year; whereas customers yearn for certainty and high quality of goods and services. Suppliers expect compensation for services and goods delivered. All these parties have one common interest; they all expect and want a continued trading relationship. No matter who the shareholder is, all are equally important to the firm. They all have legally binding contracts with the firm thus their interest should not be ignored and put to the side.

Conflicts of Interest between Shareholders and Managers

Firstly, there has been conflict between the above mentioned parties over compensation. According to Jensen and Murphy’s study (1990), managerial compensation and performance is the same with the conflicting interest between managers and shareholders. Today, market value of firms is directly correlated to the compensation managers get, not their performance.

There are some situations when shareholders pose a takeover threat from managers. This results in competition