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Role of Corporate Governance in Organization

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 GSTF International Journal on Business Review (GBR), Vol.2 No.3, March 2013

Role of Corporate Governance in Organization

Ramazanali Royaee, Bahareh Banitalebi Dehkordi, Islamic Azad University

Abstract--Following the great financial infamy in big Embezzlement and financial corruption of the manager and
companies, like Enron, World Com, Adelphi, Cisco and …, send out the stockholder’s interests fro the company, are some
one of the most issues noticed by researchers and suggested fanatic examples of this interests contrast. This agency problem
from investors is Corporate Governance, addressing the shows the need to control companies’ management through
need for company management control, dividing their own stock holders. Nowadays, the corporate governance
economical unit from its ownership and improving the term is a concept being noticed and developed in the business
performance of the board of managers, auditors, world. Corporate governance is the foundation of the company
accounting system, internal control, and finally maintaining relations with other interested groups. In general statement
investors and stakeholders’ rights. Using better managers corporate governance is a system to control and supervise the
in companies results in improvement of their performance, company. Such as system determine, control, and divest the
leading to stockholders rights too; consequently financial relations between a company and its stock holders. At small
yields will be increased and company control will be better level, corporate governance considers achievement to
performed. Corporate Governance importance in the world company’s goals, and at large level it considers optimal
is at some extent that Standard & Poors institute has devotion of the society interests. Corporate governance
introduced following multiple criteria to measure corporate includes a set of control mechanism in and out of the company
governance status: ownership structure, financial that suitably adjust stockholders rights at one hands and the
stockholders relationships, structure and how- to- act of the needs and the options of the board of the managers at the other
board of managers, and clearance and disclosure of the hands. Finally, this mechanism provides a useful guarantee for
information. Due to the issue importance, this article will stockholders, financial resources providers as well as other
define the corporate governance and its conceptual stockholders in relation with their interests’ maintenance [3].
framework, types of existed theories, types of the corporate
governance, and comparing them with each others as well II. Corporate governance definitions
as attempting to develop corporate governance.
Corporate governance has been suggested as one of the most
Index Terms--Corporate Governance, agency theory, important commerce terms of the 21 the century. Analyzing
transactions cost theory, stockholders theory, organization the existed literature indicates that there is no definition
and stewardship theory. agreed with the corporate governance system. There
significant differences between the definitions of the
I. Introduction corporate governance system based on cultural, economical,
and other conditions of ach country, there for, these
Starting the corporate governance through stocks ownership definitions locate in the range included from in finite views
had a significant influence on company’s control methods. to advanced views. Term logically, “Governance” which we
Jensen and Mackling (1976) suggested the agency theory define it as structure and performance of a company in
basics and defined the manager and stockholder as agent and respect with public and private stockholders, is synonym
employer respectively. In their analysis a stockholder is in with words like, governance, reference, supervision, and
against of a manager. One of the essential hypothesis of the control, which their nature is accountability of managers to
agency theory is that employer and agent have opposite owners [2].
interests[13]. There for, separation of the governance from
management resulted in an organizational problem called Youndong Luo writes corporate governance system, is a
agency. The most original problems deal with agency is the system governing the stock companies, and determining
contrast between manager and stockholder. Namely, a frameworks, wage division methods, and responsibilities,
stockholder tries to achieve the highest step of the investment among different stack holders of the company. It also
value and a manager initially tries to increase his/her own illustrates roles and procedures of deciding about the
wealth. So, it is possible that the manager do not act in line company affairs [5].
with stockholder’s interests [17].
In finance and accounting literature, corporate governance is
define as: “the range of control system to maintain and
DOI: 10.5176/2010-4804_2.3.224
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increase the interests of the commercial units stockholders • Cost theory, which is in due of economics and
[12]. In fact, corporate governance is a system which control organization theory.
procedures of the companies operating to ensure the • Stockholders theory, which in due of a social view
adaptation of the manager with the stockholders’ interests, about corporate governance issue.
are directed with. Such a system suggests the relations • Organization and Stewardship theory[4].

between different groups in order to determine the 1) Agency theory

company’s direction and performance. It also states the roles
and methods, determining how/ infavor of whom the
• Cohen et al . v…) states that previous articles on
companies are governed .Corporate governance does not deal
accounting, finance, and management have shown different
with governing the company performance, but it relates with
views about corporate governance. First view, being
business direction, control and supervision of the managers
extensively suggested in accounting and finance, focuses on
actions, as well as being accountability to all stockholders.
agency theory [11]. Agency theory view on corporate
Generally stated, corporate governance addresses the way of
governance has been contributed by Michel Jensen et al.
governing/controlling the companies, specially role of the
(1998), supposing properties delegation and using a new
board of managers in this respect, and it provides a
definition from stock company. The main result of properties
framework for an intuitional accountability system.
delegation in companies is separation of the companies
owners from those who are responsible for daily control of
Definitions of corporate governance in scientific texts have companies operations; namely all the persons, having
common characteristics, which one is accountability. These interests in an organization such as holder of the company’s
definitions focus on the accountability to stockholders and stocks, staffs, providers, costumers, and those who being in
other stack more advanced definitions show that companies flounced by the organization activity[13]. This theory tries to
are responsible against all the society, future generations, as convince managers to increase stockholders interests and the
well as natural resources. In this view, corporate governance company profit instead of their own interests. In agency
system deals in fact within/ex- organizational barriers, crows, theory, owners delegate their companies governance to the
and adjustment. Existed for companies, insuring that they managers, and since managers do not necessarily decide in
perform their responsibility toward all the stockholders and favor of the owner, this separation will lead to appearance of
act in all business settings in a responsive manner. Also, agent problem and moral risk. In this respect, two hypothesis
logic rational in this view is that stockholders’ in tersest are were introduced. In first hypothesis, it is stating that there is
only satisfied through considering all stockholders interests; contrast between the manager and the owners, and there is no
because, companies, being responsible toward all stock agreement between their action and the main target of the
holder, are of more yield and success in the long term. companies, being wealth increase; even though this kind of
Companies can improve their value- making in long term, perform will be against the stockholders interests. There for,
and this occurs through accomplishing their responsibility managers usually invest on the plans with short term
toward all stockholders, and optimizing their governance interests, and do not pay attention to the company interests,
system in a suitable manner [20]. The studies conducted on or they incline toward the separated incomes leading to
corporate governance paid special attention to structure and decrease of stockholders’ welfare and interest value. In
performance of the board of managers, auditory committee, second hypothesis, it is suggested that owners hear some
and other similar boards. problems in confirming the managers actions. To confirm
performance of managers, the following methods have been
Organization and Stewardship theory: the other provided:
characteristic of the definitions is to maintain the minor • Using independent auditor
stockholder rights as well as defense from stockholders and • Providing voting right for stockholders in general
their rights. Using better managers in companies leads to assembly
improve the company performance as well as increase the • Agency costs
stockholders rights. As a result, the company’s financial yield • Plans and coached contracts [10].
will increase and its control will be better done. Legal and
cultural issues, as well as revelation and changes in capital’s
In agency theory, corporate governance has been noticed as a
market result in development of the corporate governance
system and mechanism for controlling behavioral interests of
theory.
the management. From agency theory prospective,
performing the role of revision should be independence of
III. Conceptual Framework of Corporate Governance managers. As a result, what is noticed more in this theory is
independence of management from control and revision role.
All definitions of the corporate governance system follow This theory deals with the case that one delegates response
common target, and it in colludes providing control on ability of the deciding about financial resources, or
management to perform given duties and maintain performing some services following even contract to another
stockholders’ interests. Generally, these views have been person. Former will be called owner (or employer) and the
resulted in suggesting theories for corporate governance latter will be called agent (or executor). The relationship
system, which they include: between stock holder and manager as well as executive
manager and the managers of the different department of an
• Agency theory, which is in due of economical and organization are some examples of agency theory. Those
financial issues. problems being appeared from agency theory are:
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• Existence of interests contrast between stockholder and appearently composed to maintain the stockholders’ interests,
manager; it means that the stockholder tries to reach to these views are combination of both company management
the highest investment value, and the manager tries to and board of managers, and there is no stockholder. In these
initially increase his/her own wealth, theories, also there are not other stockholder or society[19].
• Inability of stockholder in considering manager’s
actions/ operations, 3) Stockholders theory
• Effects of in farmed an in favorable election,
• Moral risk, This theory, being a combination of social and organizational
theories, begun to develop in 1970th; it is more an extensive
In the condition of assurance lack to future occurrences, research, That mixes philosophy, ethics, political theories,
a contract between stockholder and manager is economics, lows, organizational as well as social sciences
concluded. In accordance with above cases, agency with each other (wheeler et al). Foundation of this theory is
theory will be effective and useful if it follows from 4 that companies become more great, and their influence on the
ethical principles” to avoid from damaging others, to society is so deep that is should pay attention/accountability
respect others’ votes, to avoid from Lying and accept to much more sections of the society, having mutual interests
agreement. Beside above cases one should consider (except stockholders); in the other words, not only
following two actions: stockholders are influenced by the company, but they also
influence on the companies. They, in the companies, have
• A suitable contract in which wage rate, company risks, interests rather than stocks. Stakeholders include
as well as manager/stockholders shares from resulted stockholders, staffs, sellers, costumes, debaters, neighbor
profit have been determined. companies, and public restricted to conforming the
• A suitable information/accounting system, providing managers’ decisions, trying to satisfy they requiring
necessary data based on contracts, should selected by themselves to satisfy all of the stockholders’ right or in other
them. In formation of this system should commonly be words they are responsible against all stockholders, they will
considerable and invaluable for both parties[1]. move successful in long term and the probable of reaching to
determined goals will be more to them. In fact, this theory
states the responsibility of the company against these
2) Transaction cost theory members. Also, company’s goal in this theory, wealth or
value creation for stock holders, are satisfied through
This theory, which is an inter- course combination of changing their stocks to goods and services. In stakeholder
economics, laws, and organization, first in the name of model, the view of agency theory is dominated. In this view,
company behavioral theory was suggested by Cyert and management as those individuals who depending on the
March (1963), and become one of basics in industrial board of managers are investigated to determine certain
economic and financial theory [16]. This theory bases on a information, and here the role of the board of managers has
foundation that, making companies so great that they been changed to supervisor. In this view, like agency theory,
substitute with market in resources so great that they the board of managers a long with other managers arranges
substitute with market in resources devotion. Indeed, procedures and strategies of the commercial unit, and its
companies are so complex and extended that they adjust focus is generally on defining new products, markets, and
market’s transactions, and direct production in accordance new technologies, as well as helping to executive
with price flexibility of the market. Inside the companies, management and strategic plans. As a result, it should be
some transactions are removed, and the companies’ managers noted that in this view, skill, proficiency, knowledge, and
adjust production with those transactions that they prefer ability are external resources[5].
themselves [9]. Transaction cost theory supposes that people
often upper realistic, while the agency theory addresses the 4) Organization and Stewardship theory
ethical risk and agency costs. Agency theory supposes that
managers try to achieve diverted incomes, while in
transaction cost theory, managers arrange themselves This theory includes in estimations and acknowledgments
opportunistically. Other difference is that the unit of analysis that determine how to delegate power, facilities and profit of
in agency theory is individual, while in transaction cost the company between owners, managers, and other
theory the unit of analysis is transaction. However, both stockholders via governments. Ownership structure and legal
theories address one problem: how do convince the manager frameworks are the most basic and determining factors of the
trying to increase company profit and stockholders’ in long corporate governance system. Also, external factors, like,
term rather than reach to own interests? This view focuses on rates of investment from in/out side, global economic status,
managerial control [14]. In comparison with agency theory, stock supply in other countries markets, and in outflow
this view states corporate governance as an inevitable investment will affect the corporate governance in a country.
variable. In revision, corporate governance has no effect, and In this theory, it is stated that managers are good agents in
in management dominant it is clearly a symbolic term. In the companies. Because they try to improve the company’s
fact, master managers select members of the board of profits and stockholders’ yields to a high level. Also,
managers instead of independent individual from his/her managers excite with the need to be responsible, and this
friends [15]. Members of the board of managers are as makes their work better[7].
passive individual in governance procedure, and they depend
on the company’s managers for information about industry IV. Classification of the corporate governance system
and company .Although, corporate governance is an
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According to the conducted studies, each country’s corporate V. Clearance and discloser in the corporate governance
governance system is characteristic, and existed corporate
governance systemic a country is determined by a number of Disclosure issue is an important section in the corporate
internal factors, such as owner ship, economic status, legal governance. The more clear the internal operation of the
system, government policies, and culture. Owner ship company and its cash flowing is, and it is reported more
stricture and legal frameworks are the most basic and accurate, the more limited will be the cases of embezzlement
determining factors of the corporate governance system. and bad- management for managers and major stockholders.
Also, external factors, like rates of investment from in/out Thus, disclosure rules must be seen as requirements of the
side, global economic status, stock supply in other countries member ship in bourse market. The important issue about
markets, and intra boarder investment will affect the disclosure is that all the effective factors on the stock’s price
corporate governance in a country. Maybe, there are should be reported accurately in the correct time. This
governance systems in the number of countries having such a information primarily includes: income list, changing in
system in common, however, all of these systems classify in board of managers, properties’ sales and buyer, owner ship
two major groups. percent of executive managers, and change in the company’s
owner ship. Other information being disclosure at next step
Relational or in- organization system: are: the amount of the rewards for board of managers,
company strategy, and the money circulation under the
In organization governance system is a system in which balance sheet. However, clearance is one of the essential
confirmed companies of any country are under owner ship of factors in a corporate governance system. Clearance deals
a few number of major stockholders; they might be the with disclosure of facts for all the stockholders. Disclosure
members of founder’s family or a small group of criticizes the operation of work market hypothesis. Dis
stockholders, such as creditor banks, other companies, or closure is a different forms of supplying information by the
government. In- organization systems are also called company through annual reports of managers’ proceedings,
relational systems because they have close and common investigation of operational and financial states of the
relations with the companies and their major stockholders. company, cost and profit list, balance sheet, cash circulation
Although, in this model so to the close relations between list, and the other items. All disclosure cases locate in the
owners and managers there are a litter problems, but because content of the company risk.
of little separation level of the ownership and management
control, the power is always being abased and minor VI. Corporate governance applying strategies
stockholder may not be aware of the company operation. The
other problem of this system is little clearance and the The articles, distributed by BAL committee, show that
possibility to abuse[4]. essential methods and strategies of applying corporate
governance are included as:
Ex- organizational system
1) Recognition of organizational values, traditions,
In this system, great companies are controlled by the performance, and other operational standards, as well as
managers, and stockholders have no role in company’s a system in which performance adaptation with above
management, and they only effect on managers’ selection. maintained cases is being guaranteed.
This leads to separation of owner ship from management. As 2) Existence of an integrated organizational strategy, in
being seen in agency theory, there is the problem of heavy which total success of the organization and individual
costs, exposed to the stockholder. Although, in ex- role in that are measures.
organizational system, companies are directly controlled by 3) Clear appointment of decision makers and important
managers, they are indirectly under the control of the ex- persons, leading finally to form a hierarchy that
organizational members, including financial institutes and facilitates the possibility of executive control by the
individual stockholders. board of manager.
4) Creating mechanisms that cause interaction and
Comparing two system: in in- organizational system, cooperation between executive manager, and board of
companies are under owner ship of stockholders; managers.
stockholders control managers but much of this control is in 5) Existence of systems for powerful internal control,
the hands of a small groups of them; separation between including internal and independent auditory operation
ownership and management is not occurred, and there for in addition to business risk management that acts
agency problems ore rarely seen; ownership focus is on a independent from commercial operation.
small group of stockholders; and there is wealth transfusing 6) Certain supervision, on the cases that contrast between
process between minor and major stockholders- In the stake holders interests is considered; Also, knowledge it
companies’ law, legislator will see a strong protection for as a risk creating factor. These cases include
investor, and there is also the possibility of power abusing in commercial relations between long loanee from banks,
front of the major stockholders, while, in ex- organizational major stockholders, comer cial management, and other
systems, great companies are under the control of managers. in-organizational decision makers.
But in owner ship all stockholders are ex-organizational, here 7) Developing a managerial and financial rewarding
there are agency problems, ownership diverse, control is in system for correct financial management, intermediate
the hands of a great group of stockholders, and the possibility management, and staffs. This encouragemantes might
of stockholder’s democracy is considered. be in the forms of wage increase, improvement or
intermediates of mental encouragement.
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[17] Wolfson N., The modern corporation: free Market Corresponding Author: Bahareh Banitalebi Dehkordi is with
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University, Shahrekord, Iran. Email: [email protected]
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Ketabgostarco,2005,pp.99-113 Ramazanali Royaee is with the Department of Accounting, Science
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