Theories and Models of

Corporate Governance
Saif Ullah Khan
Corporate Governance
What is Theory

 Theory is a supposition or a system of ideas

intended to explain something specially one
based on general principles independent of
the thing to be explain.
 A set of assumption, prepositions or accepted
facts that attempts to provide a plausible or
rational explanation of cause and effect
relationships among a group of observed
phenomenon.
 1. Agency Theory

 In corporations, shareholders act as Principles, while

management acts as the Agents.
 But the agents may be taking actions that are not in
the best interests of the shareholders, that creates a
problem call agency problems.
 The cost inflected by this problem is called agency cost.
 The loss caused by the agents to the principals is called
agency loss.
 This could be because:
1. Inadequate disclosure of information.
2. Principals are scattered and the agents are organized.
3. Principals are not organized enough.
Agency Theory Suggestions

01 02
Fair and Efficient and
accurate independent
financial board of
disclosures. director.
  It assumes that managers are basically trustworthy
and attach significant value to their own personal
reputations.
 It defines situations in which managers are stewards
whose motives are aligned with the objectives of
their principals.
2.  The responsibility of the board to its shareholders and

Stewardship employees is that of stewardship and trusteeship.

 Given a choice between self-serving behavior and
Theory the pro-organizational behavior, a steward’s
behavior will not depart from the interests of his/her
organizations.
 Control can be potentially counterproductive,
because it undermines the pro-organizational
behavior of the steward, by lowering his/her
motivation.
Behavioral Differences Between Agency
Theory and Stewardship Theory

Agency Theory Stewardship Theory

Managers act as agents
Governance approach is materialistic
Behavior patter is:
- Individualistic
- Opportunistic
- Self-Serving
Managers are motivated by their own objectives
Interests of the Managers and principals differs
The role of the management is to monitor and control
Owners’ attitude is to avoid risks
Principal – Manager relationship is based on control
Managers act as stewards
Governance approach is sociological & Psychosocial
Behavior pattern is:
- Collectivistic
- Pro-organizational
- Trustworthy
Manager’s are motivated by the principal’s objectives
Interests of the managers and principals converge
The role of the management is to facilitate and
empower
Owners’ attitude is risk taking
Principal – Manager relationship is based on trust
Psychological Mechanisms of Agency
Theory and Stewardship Theory
Agency Theory
Motivation Revolves around:
- Lower order needs
- Extrinsic needs
Social comparison is between
compatriots
There is little attachment to the
company
Power rests with the institution
Stewardship Theory
Motivation Revolves around:
- High order needs
- Intrinsic needs
Social comparison is between
principals
There is great attachment to
the company
Power rests with the personnel
Situational Mechanisms of Agency Theory
and Stewardship Theory

Agency Theory Stewardship Theory

Management philosophy is control oriented Management philosophy is involvement oriented
To deal with increasing uncertainty and risk, the theory To deal with increasing uncertainty and risk, the theory
advocates exercise of: advocates exercise of:
- Greater control - Training and empowering people
- More supervision - Making jobs more challenging and motivating
Risk orientation is done through a system of control Risk orientation is done through trust
Time frame is short term Time frame is long term
The objective is cost control The objective is improving performance
Cultural differences revolve around: Cultural differences revolve around:
- Individualism - Collectivism
- Large power distance - Small power distance
  The stakeholder theory is grounded in many
normative, theoretical perspectives including:
3– 1. Ethics of Care

Stakeholder 2. Ethics of Fiduciary Relationships

3. Social Contract Theory
Theory 4. Theory of Property Rights
Stakeholder Theory (Criticism)

“Woolly Minded Liberalism”, mainly because it is not

applicable in practice by corporations.

There is limited empirical evidence to suggest a linkage

between stakeholders concept and corporate performance.

It is difficult to define the real stakeholders.

4 – Sociological Theory

Resource Dependency
Theory

Transaction Cost Theory

Moral Hazard Theory

Political Theory

Ethics Theories
4.1 – Resource Dependency Theory

This theory concentrates on the role of board of directors in

providing access to essential resources needed for an
organization through their linkages to the external environment.

According to this theory are four types of directors:

The business Support Community
The insiders
experts Specialist Influential
 4.2 – Transaction Cost Theory

01 The organization and structure of a firm cam determine price and production.

02 The unit of analysis is transaction.

03 Therefore, the combination of people with transaction suggests that transaction cost.

04 Managers are opportunists and arrange firm’s transaction to their interests.

05 Theory emphasizes the need of strong legal mechanism to deal with opportunistic behavior.

The cost of controlling this behavior is called transaction cost and reduces the overall profits of an
06 organization.
4.3 – Moral Hazard Theory

Conflict of interest between the shareholders and the

managers leads to opportunistic behavior on the part
of the directions.

There is also asymmetric information availability

between the directors and the owners.

This can be overcome by appropriate

remuneration policy to the directors by constituting
a separate remuneration committee.
4.4 – Political Theory

01 02
According to this theory Organization is seen as a
organizational strategy democracy and
should not be driven by decisions are reached by
the sheer number of consensus making.
shares but by gathering
political support.
4.5 – Ethics Theories

Business Ethics Theory

The Virtue Ethics Theory

The Feminist Ethics Theory

The Discourse Ethics Theory

The Post-modern Ethics Theory

Board of Directs Models

1. Traditional Model
2. Craver Model
3. Collective Model (Small Organization)
4. Operational Model (Nonprofit Organization)
5. Management Model