Summary Corporate Governance Articles

Corporate Governance

Week 1: Introduction to Corporate Governance

(Corporate Governance Matters) Chapter 1: Introduction to Corporate Governance

by Larcker and Tayan (2011)

The need for CG rests on the idea that when separation exists between the ownership and the management, self-interest executives have the opportunity to take actions that benefit themselves, with shareholders and stakeholders bearing the cost of these actions → agency problem, with the costs resulting from this problem described as agency costs. To lessen the costs, some type of control or monitoring system is put in place → corporate governance (CG).

Not all individuals are uniformly and completely self-interested. Moral salience: the knowledge that certain actions are inherently wrong even if they are undetected and left unpunished (depends on personality, religious convictions, personal and financial circumstances, company involvement etc.). The need for a governance control mechanism to discourage costly, self-interested behaviour therefore depends on the size of the potential agency costs, the ability of the control mechanism to mitigate agency costs, and the cost of implementing the control mechanism.

We define CG as the collection of control mechanisms that an organization adopts to prevent or dissuade potentially self-interested managers from engaging in activities detrimental to the welfare of shareholders and stakeholders.

For a governance system to be economically efficient, it should decrease agency costs more than the costs of implementation.

Shareholder perspective vs. Stakeholder perspective

• Shareholder perspective: the viewpoint that the primary obligation of the organization is to maximize shareholder value. effective CG should increase the value of equity holders by better aligning incentives between management and shareholders.  Shareholders have both cash flow and control rights.
• Stakeholder perspective: the viewpoint that the organization has a societal obligation beyond increasing shareholder value, effective governance should support policies that produce stable and safe employment, provide an acceptable standard of living to workers, mitigate risk for debt holders, and improve the community and environment. Stakeholders ought to receive control rights.

A broad set of external forces that vary across nations also influence the structure of the governance system. These include the efficiency of local capital markets, legal tradition, reliability of accounting standards, regulation enforcement, and societal and cultural values. These forces serve as an external disciplining mechanism on managerial behaviour.