Module - 2

Systems and Theories of

Corporate Governance
 Contents of the Module
• Systems and Theories of Corporate Governance:
• Corporate Governance Models:
• Anglo American model,
• German model,
• Japanese model,
• Indian model.
• Theories of Corporate Governance:
• Agency Theory,
• Stewardship Theory,
• Stockholder/ Shareholder Theory.
• Corporate Governance during Covid-19 pandemic
 Systems of Corporate Governance- Anglo-American Model
• This is also known as Unitary Board model in which all directors participate in a single board comprising
both executive and non-executive directors in varying proportions.
• This approach to governance tends to be shareholder-oriented. It is also called as Anglo-Saxon approach
being the basis of corporate governance in America, Britain, Canada, Australia and other common wealth
countries including India.
• The major features of this approach are:
• The ownership of companies is more or less equally divided between individual shareholders and institutional shareholders.
• Shareholders have the right to elect all the members of the Board and the Board directs the management of the company.
• Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and
compensation committees.
• Directors are rarely independent of management.
• Companies are typically run by professional managers who have negligible ownership stakes. There is a fairly clear
separation of ownership and management.
• Most institutional investors are reluctant activists. They view themselves as portfolio investors interested in investing in a
broadly diversified portfolio of liquid securities. If they are not satisfied with a company’s performance, they simply sell the
securities in the market and quit.
• The disclosure norms are comprehensive, the rules against insider trading tight, all of which provide adequate protection to
the small investor and promote general market liquidity. Incidentally, they also discourage large investors from taking an
active role in corporate governance.
• Microsoft and HP
Systems of Corporate Governance- Anglo-American Model
 Systems of Corporate Governance- German Model
• This model is also known as the two-tier board model/ Corporate Governance is exercised
through two boards, in which the upper board supervises the executive board on behalf of
stakeholders.
• This approach to governance is typically more societal-oriented and is sometimes called
Continental European approach and the basis of corporate governance adopted in Germany,
Holland, and to an extent, France.
• Key features of this model are:
• Shareholders own the company but they do not entirely dictate the governance mechanism.
• Shareholders elect 50% of members of supervisory board and the other half is appointed by labor unions.
This ensures that the employees and laborers also enjoy a share in the governance.
• The supervisory board appoints and monitors the management board.
• There is a reporting relationship between them, although the management board independently conducts
the day to day operations of the company.
• Government and national interest are strong influences in the model, and much attention is paid to the
corporation's responsibility to submit to government objectives and the betterment of society.
• Banks also often play a large role financially and in decision making for firms.
• Audi and BMW
Systems of Corporate Governance- German Model
Systems of Corporate Governance- Japanese Model
• This is the Business network model, which reflects the cultural relationships seen in the
Japanese keiretsu (loyalty between suppliers and customers) network, in which boards
tend to be large.
• The reality of power lies in the relationship between top management in the companies
in the Keiretsu network.
• The approach bears some comparison with Korean Chaebol (large family-owned
business conglomerate)
• Main features of this model are:
• Financial Institutions play a crucial role in governance.
• The shareholders and the main bank together appoint the board of directors and the president.
• The President decisions are ratified by the Supervisory board and President consults Executive
Management for decision making.
• Corporate transparency is lacking in the Japanese model given the interrelationship and
concentration of power among the many Japanese corporations and banks
• Individual investors are seen as less important than business entities, the government, and union
groups.
Systems of Corporate Governance- Japanese Model

[Link]
Corporate Governance: [Link]
[Link]
[Link]
 Systems of Corporate Governance- Indian Model
• The Indian corporates are governed by the Company Act 1956 that follows more
or less the UK model.
• The private companies are closely held or dominated by a Founder, his family
and associates.
• SEBI appointed Kumar Mangalam Birla Committee, Narayana Murthy
Committee and Government appointed Naresh Chandra Committee suggested
measures for improvement based on what has globally recognized as ‘best
practices’.
• Corporate Governance in India is a set on internal controls, policy and
procedures which form the framework of a company’s operations and its
dealings with various stakeholders such as customers, management, employees,
government and industry bodies.
Systems of Corporate Governance- Indian Model
 Agency Theory
• Agency theory examines the relationship between the agents and principals in
the business. The theory revolves around the relationship between the two and
the issues that may surface due to different risk perspectives and business goals.
• The shareholders, true owners of the corporation, as principals, elect the
executives to act and take decisions on their behalf. The aim is to represent the
views of the owners and conduct operations in their interest.
• Despite this clear rationale for electing the board of directors, there are a lot of
instances when complicated issues come up and the executives, knowingly or
unknowingly, take decisions that do not reflect shareholders’ best interest.
• In the dynamic business environment, the agency theory of corporate
governance has garnered much attention and is seen and evaluated from
different points of view.
 Agency Theory contd…
• The dividend payout policy of a corporation. The majority of shareholders
expect high dividends payouts when the company is making huge profits. With
this, not only do they enjoy extra cash on their hands, but it also boosts the
current value of the capital stock they hold.
• The executives, on the other hand, as a part of the long-term strategy, may
decide to retain a large part of profits. Retention could be for a requirement of
some technology advancement or some critical asset purchase in the near future.
• A conflict of interest may arise between the shareholders and executives in such
situations. Such disagreements can create a feeling of contention between the
owners and controllers of the company, often resulting in inefficiencies and
sometimes even losses.
 Agency Theory contd…
• Agency theory in corporate finance is gaining momentum for all the right
reasons. With markets getting volatile as ever, it becomes imperative that both
the interests of the shareholders and the company are taken care of.
• The shareholders should trust the company’s management and go the extra mile
to understand their day-to-day business decisions.
• Similarly, the management should also keep the interests of the company’s true
owners in their mind.
• Clear communication should be sent out explaining the rationale behind major
business decisions to help shareholders understand and appreciate changes, if
any.
• A robust corporate policy can help to keep differences at bay.
 Stewardship Theory
• For Stewardship theory, managers seek other ends besides financial ones. These
include a sense of worth, altruism, a good reputation, a job well done, a feeling
of satisfaction and a sense of purpose.
• The Stewardship theory holds that managers inherently seek to do a good job,
maximize company profits and bring good returns to stockholders. They do not
necessarily do this for their own financial interest, but because they feel a strong
duty to the firm.
• The theory holds that individuals in management positions do not primarily
consider themselves as isolated individuals. Instead, they consider themselves
part of the firm. Managers, according to stewardship theory, merge their ego and
sense of worth with the reputation of the firm.
 Key points of stewardship theory:

[Link] and Commitment – Managers are seen as trustworthy individuals who

naturally align their goals with the company's success.
[Link]-Term Growth – Focuses on sustainable performance rather than short-
term profits.
[Link] – Encourages a strong relationship between managers and
shareholders rather than control and monitoring.
[Link] Motivation – Managers are motivated by achievement, responsibility,
and organizational success rather than external rewards.
 Stewardship Theory contd….
• The consequences of stewardship theory revolve around the sense that the
individualistic agency theory is overdrawn. Trust, all other things being equal, is
justified between managers and board members.
• In situations where the CEO is not the chairman of the board, the board can rest
assured that a long-term CEO will seek primarily to be a good manager, not a
rich man.
• Alternatively, having a CEO who is also chairman is not a problem, since there
is no good reason that he will use that position to enrich himself at the expense
of the firm.
• Put differently, stewardship theory holds that managers do want to be richly
rewarded for their efforts, but that no manager wants this to be at the expense of
the firm.
 Stockholder/ Shareholder Theory
• The Friedman doctrine, also called shareholder theory or stockholder theory or shareholder primacy theory. Milton
Friedman
• Shareholder theory is the view that the only duty of a corporation is to maximize the profits accruing to its
shareholders. This is the traditional view of the purpose of a corporation, since many people buy shares in a
company strictly in order to earn the maximum possible return on their funds.
• If a company were to do anything not associated with earning a profit, the shareholder would either attempt to
remove the board of directors or would sell his shares and use the funds to buy shares in some other company that is
more committed to earning a profit.
• Under shareholder theory, the only reason management is working on behalf of shareholders is to deliver maximum
returns to them, either in the form of dividends or an increased share price. Thus, managers have an ethical duty to
the owners to generate significant value.
• To take this concept one step further, a corporation should not engage in any type of philanthropy, since that is not
its purpose. Instead, the corporation can deliver dividends to its shareholders, who then have the option to donate
the money for philanthropic purposes, if they choose to do so. The only case in which a corporation should donate
money is when the amount of the donation creates a benefit that is approximately equivalent to or greater than the
amount of the donation.
• Shareholder theory has been criticized by proponents of stakeholder theory, who believe the Friedman doctrine is
inconsistent with the idea of corporate social responsibility to a variety of stakeholders. They argue it is morally
imperative a business takes into account all of the people who are affected by its decisions. They also argue that
taking into account the interests of stakeholders can benefit the company and its shareholders;
 Stockholder/ Shareholder Theory
• Central to this model is the axiom of shareholder primacy, which presupposes that
corporations should mainly be managed for the welfare of shareholders. Arising out of such
a presupposition is that theoretically a residual power rests with the shareholders so that
they can choose the persons to whom operational power is delegated. It also entitles them
to participate in major corporate decisions, including exercising the power of hiring or
firing the board of directors, usually at an annual general meeting (AGM). In practice,
however, it has been contended that the ability of shareholders to meaningfully exercise
such control over the direction of their company is severely limited by the very procedures,
which govern such meetings and corporate officers elections. For example, it is directors
rather than shareholders that typically set the agenda of an AGM, and by implication
directors determine the issues that come up for voting. By contrast, it has been shown that
it is either difficult or impossible for shareholders to get binding resolutions of their own
onto the agenda.
• The theory is criticized for ‘unethically’ strengthening further the already rich and powerful
societal segments – shareholders and managers rather than empowering the weaker
sections of society – lower level employees, local communities, the poor, women and
children.
 Corporate Governance during Covid-19 pandemic
• COVID-19 and Comparative Corporate Governance ([Link])
End of the Module 2