What is Corporate Governance? Meaning and Theories

corporate governance

What is Corporate Governance?

Corporate governance is a system which implies that the company manage its affairs with diligence,transparency,responsibility and accountability and would result in wealth maximization of shareholders. Hence, it requires to design systems, processes, procedures, structures and take decisions to augment its financial performance and stakeholder value in the long run.

Theories of Corporate Governance

There are four theories of corporate governance which are as follows –

1. The Agency Theory

The main motive of any firm is that its manager must maximize the shareholder’s wealth.However, the wealth maximization model may not work due to agency problem. The basis of the agency theory is the separation of ownership and control. The principals or shareholders own the company, but the manager or agents control the company.

The powers possessed by the managers motivate them to expropriate the company’s wealth to themselves. Thus, they may not work to maximize the owner’s value. Under agency theory of corporate governance, the main focus on to develop rules and incentives, based on implicit or explicit contracts to eliminate or at least, minimize the conflicts between managers and shareholders.

2. The Stakeholder Theory

This theory based on the foundation that the primary motive of the manager is to maximize the wealth of the stakeholders rather than only shareholders. Hence, here the corporate governance focuses on to empower those stakeholders who contribute or control critical resources and skills and to ensure that that interest of these stakeholders are align with that of shareholder.

3. The Political Theory

The theory states that it is the government that decides that allocation of control, rights, responsibility, profit, etc. among owners,managers,employees and other stakeholders. In addition to this, every stakeholder should try to enhance its bargaining power to negotiate higher allocation in its favor.

4. The stewardship theory

This theory view managers as stewards. They are assumed to work efficiently and honestly in the interests of company and owners.  Basically, in this theory of corporate governance, managers are self motivated and goal oriented.

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