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Corporate governance has a positive link to corporate performance Essay

Internationally, over the past few years, much emphasis has been placed on the importance of corporate governance. In a recent study Moxey (2002) argued that there is a growing consensus that corporate governance has a positive link to corporate performance. Countries with high standards of corporate governance practices are more likely to attract international capital. If corporate governance had been deeply flawed, the current level of national productivity could not be achieved.

Generally speaking, large incorporated businesses are usually owned by one group of people (the owners or shareholders) whilst being run by another group of people (the management or the directors). This separation of ownership from management creates an issue of trust, called Agency problem. The management has to be trusted to run the company in the interest of the shareholders and other stakeholders. If information were available to all stakeholders in the same form at the same time, corporate governance would not be an issue at all.

With the same information as managers, shareholders and creditors would not worry about the management wasting their money on useless projects; suppliers would not worry about the customer not fulfilling its part of a supply agreement; and customers would not worry about a

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supplier firm not delivering the goods or services agreed. However, in the real world of imperfect information, each agent will use whatever informational advantage they may have. Looking at conventional firms, management will usually have an informational advantage over other stakeholders.

With more and more questionable business practices appeared governments pretend to tighten the regulation around corporate governance further. In recent year the term “stakeholder” has been introduced into the language of business ethics. It sounds like going to replace the traditional term “stockholder” in dealing with questions of corporate responsibility (Marcoux, 2000). Shareholder theorists argue that managers should serve the interests of a firm’s owners- shareholders.

Whereas many commentators, such as Freeman, have argued that directors should be trying to act in the best interests of stakeholders (such as employees, local community, national interest, customers and suppliers) not just shareholders when making investment appraisal and other decisions. According to the shareholder theory, the shareholders lend capital to the managers, who act as their agents in realizing specified objectives. In this role, managers are required to spend corporate funds only in ways that have been authorized by the shareholders.

The shareholders theory is often considered simply a managerial obligation to provide the greatest financial returns to shareholders through means that are legal and not deceptive. Stakeholder theory asserts that managers have a fiduciary duty not merely to the corporation’s stockholders, but to the corporation’s stakeholders – anyone who has a stake in or claim on the firm. According to the stakeholder theory, managers have a fiduciary duty to give equal consideration to the interests of all stakeholders and to adopt policies that produce the optimal balance among them without violating the rights of any stakeholder (Donaldson, 1995).

On moral grounds there should be some level of equality of treatment between shareholders and other stakeholders. However, the idea of equality of treatment may appear attractive or fair but in many circumstances the choice is “either shareholders or stakeholders interest”. That is why there has been debate on application of shareholder theory or stakeholder theory in the corporation. e. g. , a company which buys a machine to replace skilled workers might raise returns to shareholders but damage the lives of employees and the local economy if it makes skilled workers redundant.

“The right decision” for directors managing for shareholder interest would be to buy the machine, if managing for the stakeholder interest it would not. Another example, suppose a company is emitting harmful waste which is not illegal but it could spend shareholders money on a machine to prevent the omissions. With shareholders theory managers would say “don’t clean up unless there is some specific benefit for shareholders or unless the emission becomes illegal”. However, managers in the stakeholder world should make decision on stakeholder angle.

The logic being if a company pollutes the environment then that act will rebound on the good name of that company at some time. This may affect the company’s ability to compete or their ability to motivate staff and suppliers to serve the company as well as possible. While the general perspective of stakeholder theory may be plausible, there are several inherent flaws in the conceptual and empirical foundation on which it rests. These flaws weaken it and mask some of its implications. Firstly, it is a law of nature that, if the terms of one’s theory cannot be defined, then there may be a problem with the theory.

Stakeholder theory has this fundamental obstacle: no one can seem to agree on a definition for the term ” stakeholder”. Even assuming that scholars are capable of reaching agreement on the actual definition of ” stakeholder,” there is another obstacle to the application of stakeholder theory: no one seems certain exactly how the theory should work. As Sternberg (1998) said, ” the meaning of the term ‘stakeholder’ has itself changed significantly over time. Like the criterion of being a stakeholder, the main uses of stakeholder theory have also altered radically”(Sternberg, 1998 pp.94-95).

Secondly, directors and managers of business corporations have to make a myriad of decision everyday. Each decision, however, is governed by the organisation’s fundamental purpose: to maximise shareholder value for the owners. But in a stakeholder world, a corporation could easily become accountable to almost anyone or everyone: as is well known, an organisation that is accountable to all easily becomes accountable to no one. “Multiple accountability can only function if everyone involved accepts a clear common purpose.

But that is what stakeholder theory conspicuously rejects. ” ( Sternberg, 1998, pp. 98) Thirdly, apart from the definitional and operational ambiguities and problems in stakeholder theory, there remains the problem that the concept contradicts the property law. Stakeholder theory argues that the assets utilized by corporations should be used for the balanced benefits of all stakeholders. Stakeholder theory aims to impose upon a company and its shareholders a new form of contract that grants stakeholders a say or voice in the use of the shareholders’ property.

It concerned with producing a situation of fairness, actually disadvantages those who have chosen to undertake risks that others have not. To this extent, stakeholder theory may undermine the process of issuing shares as a means of financing the corporation’s growth and new entrepreneurial ventures. For why would potential shareholders invest, if they knew that their interests would be subordinated again and again to those who had made no financial investment?

Moreover, the stakeholder theory holds a particular challenge for managers in that it does not specify how the optimal balancing of stakeholder interests should be achieved. To preserve the position of stakeholder theory, stakeholder theorists argue that the shareholder model failed to deal with contemporary societal problem. While in stakeholder model the organizations are accountable to all its stakeholders as they use society’s resources and enjoy special privileges from society. But the reality is that the corporation contributed many things to society in exchange for its use of resources.

The company can buy a supplier’s products, provide good financial value to its customers, pay high dividends to its shareholders, increase its employees salaries, pay taxes to federal, state, and local governments, make investments in financial institutions and make charitable contributions to various types of activist groups. Understanding and satisfying the needs of stakeholders is important to the well-being of the firm. In today’s highly competitive economic and social environment, no important stakeholder can be ignored (Buono & Nichols,1990).

It is the reason may explain why some people are in favor of the stakeholder theory. This reason assumes that the shareholder model focuses less on business competitiveness and survival than does the stakeholder model. However, it is obviously false. If businesses are having trouble being competitive, it probably isn’t because they have failed to consider the groups with whom they interact. It may be that they are not particularly adept at non-market strategies or in appeasing others who oppose the market.

Indeed, competitive disadvantages may result from having to cater to groups or forces that contribute nothing to successful market activity. People who advocate the stakeholder theory believe that this theory is in keeping with notions of fairness to employees, consumers, communities, etc. , not just instruments for enriching shareholders. What I want to say is that the shareholder theory doesn’t say that the managers’ only conceivable obligations are to shareholders, but rather that their primary obligation is to them because the shareholders, in effect, have hired the managers to serve their interests.

Such a relationship is tangible and direct. Contrast that with the amorphous set of obligations to anyone and everyone the shareholder theory is likely to generate. In the end it must be noted that most group considered to be” stakeholders” have no stake in corporations at all. With the possible exception of employees, stakeholder groups have no interest in the well-being of any particular corporation. True, they may have an interest in how corporations affect them, but to have a stake in something is to care about its prospects, as one might when investing in a firm.

Whether the “good” the stakeholder group wants is provided by this or that corporation doesn’t matter to them; whether the “bad” it complains of is alleviated by this or that corporation also doesn’t matter. Whether a given corporation is succeeding in the market is of no concern to these groups because they have made no commitment to it. In an age of competition from a widening variety of sources, expanding markets, and increased diversity in employment populations, businesses may feel they are being hit from all sides. The term “stakeholder” seems to capture the feeling of having to concern oneself with multiple points of impact.

However, the only true stakeholders are shareholders. Good corporate governance means running the corporation in such a way that the interests of the shareholders are protected while ensuring that the other stakeholders’ requirements are fulfilled as far as possible. The social obligations of the firm are limited to make good on contracts, obey the law and adhere to ordinary moral expectations (Windsor, 1998). Stakeholder theory can be “a useful label for all those individual and group which have to be taken into account” (Sternberg, 1998, pp. 107).

However, it can’t be considered as a modal of good corporate governance because of its imprecision in definition and execution and its disregard for property rights.

References:

Buono, A. F. & Nichols, L. T. (1990) ‘ Stockholder and Stakeholder Interpretations of Business’ Social Role,’ Business Ethics, edited by W. Michael Hoffman and Jennifer Mills Moore, New York: McGraw-Hill. Donaldon, T. and Preston, L. (1995) ‘The stakeholder theory of the corporation: concepts, evidence and implications’. Academy of management Review, 20:1, 65-91. Marcoux, A. M. (2000) ‘Business Ethics Gone Wrong’, CATO Policy Report CATO Institute July 24, 2000.

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