Corporate Governance:
Development, Theories and
Approaches
CRG 650
Learning Outcome
• Define the meaning of Corporate Governance
• Illustrate the following theories of governance:
•
•
•
•
The Agency Theory
The Transaction Cost Theory
The Stakeholder Theory
The Stewardship Theory
• Development of Corporate Governance in Malaysia
• The Corporate Governance Reforms
• The Malaysian Code of Corporate Governance
• Framework of Corporate Governance in Malaysia
• Institutional
• Regulatory Bodies (i.e. Bursa Malaysia Bhd, Securities Commission, CCM, MASB, MICG, IIM)
• Statutory
• Around the World
• The Corporate Governance in the UK
• The Cadbury Report (1992)
• The Greenbury Report ( 1995)
• The Corporate Governance in the US
• The Sarbanes-Oxley Act (2002)
• The OECD Principles of Corporate Governance
• The International Federation of Accountants (IFAC)
CORPORATE GOVERNANCE
• Various definitions from:
• Cadbury Report (1992)
• OECD Principles of Corporate Governance (1999; Revised 2004)
• Malaysian High Level Finance Committee (1999)
• Cuervo (2002)
• Gatamah (2004)
• Malaysian defintion:
• Corporate governance is the process and structure used to direct and
managed the business and affairs of the company towards enhancing
business prosperity and corporate accountability with ultimate
objective of realising long-term shareholders value, whilst taking into
account the interests of other stakeholders (Malaysian High Level
Finance Committee, 1999).
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THEORIES OF GOVERNANCE
• Agency theory
• Transaction cost theory
• Stakeholder theory
• Stewardship theory
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Agency Theory
• Jensen & Meckling (1976), identify the agency relationship between
principal & agent, whereby the principal engages the agent to perform some
services on their behalf and principal will normally delegate some decision
making authority to the agent.
• Agency Problems
1)
Adverse Selection
• Describes an undesired result due to the situation where one party of a deal has more accurate
and different information than the other party. The party with less information is at a
disadvantage to the party with more information. The asymmetry causes a lack of efficiency in the
price and quantity of goods and services.
• Principal cannot determine if the agent performing the work for which he is paid
2)
Moral Hazard
• Occurs when a party provides misleading information and changes his behavior when he does not have
to face consequences of the risk he takes.
• Principal is unsure as to whether the agent has performed their work to their ability, due to self-seeking
motives
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Agency Theory – cont’d
• Due to conflicting of interests will rise to agency cost associated
with monitoring management, creating & implementing an effective
incentive system.
• Divided to 3 categories of costs:
a)
b)
c)
Monitoring
Bonding
Residual
• The main focus on this theory is the selection of appropriate
governance mechanism between principal & agent that will ensure
an efficient alignment between both parties’ interests and minimise
agency costs.
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Categories of Agency Costs
a) Monitoring
For example, the board of directors at a company acts on behalf of shareholders to
monitor and restrict the activities of management to ensure behavior that
maximizes shareholder value. The cost of having a board of directors is therefore, at
least to some extent, considered an agency monitoring cost. Costs associated with
issuing financial statements and employee stock options are also monitoring costs.
b) Bonding
Furthermore, an agent may commit to contractual obligations that limit or restrict
the agent’s activity. For example, a manager may agree to stay with a
company even if the company is acquired. The manager must forego other potential
employment opportunities. Consider that implicit cost an agency bonding cost.
c) Residual
The costs incurred from divergent principal and agent interests despite the use of
monitoring and bonding.
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Transaction Cost Theory
• Different institutional or organisational arrangements exist principally for the
purpose of facilitating transactions i.e. reducing costs of conducting a particular
activity/production (Oliver E. Williamson, 1985).
• It is part of corporate governance and agency theory.
• It is based on the principle that costs will arise when you get someone else to do
something for you .e.g. directors to run the business you own
• Transaction costs are divided into pre- and post- transaction costs to ensure that
interest of the parties involved are protected (Daniel et al., 1997).
• Pre-Transaction Cost
• Costs that a firm incurred before transacting with other economic actors (other firms or
employees of the firm) which involved with legal contractual relationship.
Post-Transaction Cost
• Companies have to incur post agreement costs to maintain such agreement such as
monitoring & administering costs.
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Stakeholder Theory
• Firms that manage to optimise stakeholder satisfaction will be able to
thrive better than the company that only concentrates on maximising
shareholders interest (Freeman 1984).
• Every organisation or corporation was created to serve more than just its
shareholders, they should serve wide range of people that have legitimate
stake in the company’s outcome & performance which serve a broad
societal purpose.
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Stakeholder Theory – cont’d
Shareholder Theory
Stakeholder Theory
Focuses on corporate
profit maximization which
resulted to negative
consequences such as
human rights, working
condition & environment
Dictates how manager
morally should respond to
the interest or claims of
stakeholders in a proper
way as managers bear
fiduciary relationship to
stakeholders
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PYQ: January 2018; Part A; Q4
The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that
can deliver the long-term success of the company.
Required:
a) There are three (3) duties of directors in governing a corporation, namely; duty of care, duty of loyalty and
duty of obedience. Explain briefly these duties.
(6 marks)
b) The Bursa Malaysia Listing Requirements have set certain restriction for cross-directorships. It permits a
director to hold a maximum of 25 directorships at any one time, of which 10 directorships in public listed
companies and 15 directorships in unlisted companies. Explain three (3) benefits of such restriction.
(6 marks)
c) Discuss the stakeholder theory and the shareholder theory in corporate governance.
(8 marks)
(Total: 20 marks)
Stewardship Theory
• Different from Agency, this theory defines situations which managers are
not motivated by individual goals, but rather as stewards whose motives
are aligned with the objectives of their principals.
• It also acknowledges a larger range of human motives including
orientations towards achievement, altruism & commitment to meaningful
work.
• Focus on the intrinsic rewards that not easily quantified such as
opportunities for growth, achievement, affiliation & self-actualisation.
• Therefore, managers should be authorised to act since they are not
opportunistic agents but good stewards who motivated to work hard on
behalf the organisation.
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Stewardship Theory – cont’d
• Steward protects and maximises shareholder’s wealth through firm
performance, by doing so, the stewards’s utility functions are maximised
(Davis, Schoorman and Donaldson 1997)
• As such, managers balance competing shareholders’ & stakeholders’
objectives, making decisions in the best interest of all.
• From the management view, this theory favours board having a majority
of specialist executive director rather than non specialist independent
directors.
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PYQ: July 2017; Part A; Q4
Promotion of efficient and effective corporate governance has become an important agenda for businesses in
developing countries because it can enhance managerial excellence and help businesses with fragile
governance structures to increase capital and attract foreign investors (Okpara, 2009). A number of
researchers and practitioners have given different but meaningful definitions to the “corporate Governance”
concept. The concept has been broadly defined by economists and social scientists as the bodies that influence
how firms allocate resources and returns (O’Sullivan, 2000).
The OECD Principles of Corporate Governance states that “Corporate governance involves a set of
relationships between a company’s management, its board, its shareholders and other stakeholders.
Corporate governance also provides the structure through which the objectives of the company are set, and
the means of attaining those objectives and monitoring performance are determined”.
Required:
a) Explain briefly any THREE (3) roles of the Board of Directors in corporate governance.
(6 marks)
b) Explain any THREE (3) benefits of having an interlocking directorship.
(6 marks)
c) Distinguish between Agency Theory and Stewardship Theory.
(8 marks)
(Total: 20 marks)
DEVELOPMENT OF CORPORATE
GOVERNANCE IN MALAYSIA
The Corporate Governance Reform
• Due to markets globalization, competition and finance, the growing
interests in CG has been a crucial element in an organisation.
• Morever, issues that most concerning the world-wide is on the increasing
of unexpected business failures, unscrupulous directors, limited role and
lack of independence auditors, weak link between executive remuneration
& company performance (Macdonald and Beattie, 1993).
• Furthermore, one of the main reasons that lead to the emergence of CG is
the power corruption among directors in order to manage their own
conflicts of interest (Turnbull, 2003).
• In addition, based on study conducted by Tricker (2004), he also identified
few factors contribute to arisen of CG which are the emergence of private
companies, complexity of corporate groups, hostile activities of predetors,
criminalization of insider trading & changes in world international
auditing.
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The Malaysian Code of Corporate Governance
• In 1998, MICG was formally established which the objectives are to be a
leading centre for enhancement of CG development and to create public
awareness of CG.
1998
1999
2000
2007 & 2012
• Improving the CG framework
• Released report on CG called “Green Book” drafting the MCCG
• A finalized Report of MCCG was published to public in March
• Revised Code of Corporate Governance
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The Malaysian Code of Corporate Governance – cont’d
• This code aims to encourage disclosure by providing investors with timely
and relevant information upon which investment decisions are made &
evaluation of companies performance.
• It also guide to board of directors by clarifying their responsibilities & also
provides remedy to strengthen the control exercised.
• Bursa Malaysia also takes a part to the effort of enhancing CG in Malaysiaa
by revamping its Listing Requirement (LR) in 2001.
• In 2017, the latest MCCG was issued that supercedes its earlier edition
• The new Code takes on a new approach to promote greater
internalisation of corporate governance culture.
• Key features on next slide
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The Malaysian Code of Corporate Governance 2017
file:///D:/Documents/CRG650/CRG%20650%20LECTURE%20MATERIALS/8_%20CRG650%20CORPORA
TE%20GOVERNANCE%20_%20DEVELOPMENT,%20THEORIES%20APPROACHES/MCCG%202017.pdf
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The Malaysian Code of Corporate Governance 2017
file:///D:/Documents/CRG650/CRG%20650%20LECTURE%20MATERIALS/8_%20CRG650%20CORPORA
TE%20GOVERNANCE%20_%20DEVELOPMENT,%20THEORIES%20APPROACHES/MCCG%202017.pdf
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FRAMEWORK OF CORPORATE GOVERNANCE IN MALAYSIA
BODIES
Bursa Malaysia
FUNCTIONS
It operates a fully-integrated exchange, offering the complete
range of exchange-related services including trading, clearing,
settlement and depository services.
Securities Commission Statutory body entrusted with the responsibility of regulating and
systematically developing the capital markets in Malaysia.
Companies
Commission of
Malaysia (CCM)
Statutory body formed under an Act of Parliament that regulates
corporate and business affairs in Malaysia
MICG
The mandate was to raise the awareness and practice of good
corporate governance in Malaysia
IIM
Agency that align and monitor the implementation of Pelan
Integriti Nasional (PIN)
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AROUND THE WORLD
THE UNITED KINGDOM
Cadbury
Report (1992)
Myners
Report (2001)
Higgs Report
(2003)
Greenbury
Report (1995)
Turnbull
Report (1999)
Smith Report
(2003)
Hampel
Report (1998)
Combined
Code (1998)
Combined
Code (2003)
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THE UNITED STATES
• Due to the economic crisis and with the recent corporate failures,
US has issued out the Sarbanes-Oxley Act on 30 July 2002
• It aims to protect investors by improving accuracy and reliability of
corporate disclosures made pursuant to securities law, and other
purposes.
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THE UNITED STATES – cont’d
…cont’d
Increase number of independent members on board
Real time disclosure of material events
CEO & CFO to certify financial statements & internal
control
Strengthening oversight financial reporting by audit
committee
Stricter on independence standards for audit
committee
Effective communications between external auditor &
audit committee
Prohibition of loans to employees & executives
OECD Principles
Basis of
effective CG
framework
Rights of
shareholders &
function
Responsibilities
of the boards
Equitable
treatment of
shareholders
Disclosure &
transparency
Role of
stakeholders
THE
INTERNATIONAL
FEDERATION OF
ACCOUNTANTS
(IFAC)
THE
INTERNATIONAL
FEDERATION OF
ACCOUNTANTS
(IFAC) – cont’d
CONCLUSION
• Effective code of CG is the most important factors that determine
CG effectiveness.
• Recommendations provided in Malaysian Code CG:
1) Restrictions in voting rights of controlling shareholders related
to party transactions
2) Constructing an effective board
3) Enhancing board independence
4) Establishing audit committee