Experts fail to agree on a standard definition of the corporate governance concept. Therefore, it is difficult to define the idea unambiguously due to the divergent opinions regarding the nature of management. The challenges emanate from the complexity of issues related to governance and the diversity of approaches people use to explain it. The concept is vulnerable to two divergent perspectives: stakeholder-oriented and shareholder-oriented.
The stakeholder perspective of corporate governance suggests that superordinate entities emerge when different actors with genuine interests come together. The organization exists due to various groups. On the other hand, the shareholder perspective assumes that a corporation is a private entity with stakeholders, executive and non-executive directors, who manage the firm’s interests. The view suggests that corporate governance is the functioning and structure of the Board of Directors and their connection to the managers. Executives perform the daily activities of the company in the shareholders’ interests. Corporate governance can be regarded as the way of ensuring that assets, actions, and agents of the company are achieving the goals of the corporation. Therefore, to understand the contribution of corporate governance to the organizations’ ethical response, it is imperative to critically discuss how the concept has evolved over the 20th and 21st centuries.
The Evolution and Nature of Corporate Governance
The Corporate Governance theory dates back to the 20th century. Experts trace the theoretical foundation from 1932 in the United States of America. Berle and Means introduced the concept in their work The Modern Corporation and Private Property (qtd. in Fiori 11). They focused on the emerging tendency of the American corporations to separate ownership and control. The authors argue that there had been an increase in capital concentration during the past decades in a few companies, which increased their power. Firms continued to grow, making it hard for the initial owner to maintain the majority shares, spreading to many other smaller shareholders. As a result, the managers running the companies usurped more power. However, the executive’s interests fundamentally differed from those of the shareholders. Investors desired that profits would be shared as dividends. On the contrary, managers wanted to reinvest the profits to continue growing their salaries (Fiori 11). Berle and Means noted an emerging power class comprising of professional managers who were protected from pressures arising from both the shareholders and the general public (qtd. in Fiori 11). The increasing power had detrimental consequences to the business world and the society.
Many other authors emerged with similar efforts to understand the rationale for the existence of firms. Ronald Coase wrote The Nature of the Firm in 1937 to explain the reasons behind their creation and continued existence (qtd. in Fiori 12). He considers the conditions under which the owners preferred to employ people rather than a contract on a temporary basis for specific roles. Coase uses the term “transaction costs” to explain this reality and the company’s size (qtd. in Fiori 12). He defines the concept as the coordination activity between diverse actors’ wasted time and money.
Five decades later, in 1983, Eugene Fama and Michael Jensen, wrote The Separation of Ownership and Control. In the book, they propose the agency theory to explain Corporate Governance. The approach focuses on the agency relationship, where one actor (the principal) delegates tasks to another one (the agent) (Fiori 13). Thus, the theory explains the relationship between the shareholders (the principal) and the managers (agent).
Research reveals some problems arising from the agency relationship. Fama and Jensen indicate two of them. The first one is the conflicting objectives of the agent and the principal or when it is challenging or impossible for the actor (principal) to verify the goals accurately . The second problem arises from risk sharing, especially when the two have conflicting attitudes towards the issue (Fiori 13). In 1976, Jensen and Meckling used the same theory to model the agency costs in the modern corporation. They suggest that ownership and control are not entirely coincident due to potential conflicts of interests between controllers and owners. Additionally, the incapacity to write a contract and monitor the controllers leads to a value reduction for the company in the end. Some deals focus on the outcome of the principal’s interest, while others on the agent’s behavior (qtd. in Fiori 13). Although the corporate governance concept emerged early, it became widely used in the 1980s.
From the same perceptive of the agency, in Corporate Governance, Principles, Policies, and Practices, Tricker suggest the nature of people in incidents involving money (Milliken 72). Principals depend on agents to handle their businesses, leading to the concept of governance. Some experts trace the idea back to the statement made by Adam Smith in 1776: “The directors of companies, being the managers of other people’s money rather than their own, cannot well be expected to watch over it with the same anxious vigilance with which (they) watch over their own” (qtd. in Milliken 72). The idea became important in the 1980s, following corporate collapses. The Cadbury Report in 1992 became “a landmark in thinking on corporate governance” (qtd. in Milliken 72) and resulted in the pressure in the UK for companies to comply with the global corporate governance requirements. The nature of corporate governance at the time focused on the relationship between companies and their stakeholders. Corporate governance applies to the kind of the interactions between the shareholders and those responsible for the day-to-day running of the company.
Corporate governance efforts continued to develop in other countries. Hong Kong launched the original corporate governance initiative in 1992. The Project launched by the SEHK (Stock Exchange of Hong Kong) was meant to improve the corporate governance standards in the country primarily for the issuers (Yu and Rudge 8). International developments influenced the efforts to develop best practice in Hong Kong. The Code of Best Practice was created as a voluntary guideline to build their conduct relating to corporate governance (Yu and Rudge 8). The business authority system in the country continued to evolve in the years that followed. The SEHK replaced the Code of Best Practice with the Code on Corporate Governance Practices in 2005. The new system had Listing Rules, including the need for annual reports to have a corporate governance report for issuers (Yu and Rudge 8). The new system included the “comply or explain” requirement, making it more mandatory to adhere to the new regime (Yu and Rudge 11). The country had become one of the many that followed corporate governance in the operations of organizations.
The efforts in the 20th and 21st centuries focused on the recommendations on improving corporate governance. Experts had agreed on the importance of the concept in the business world with increasing complexity. For example, the Myners Report includes recommendations to improve communications between companies and investors. Creation of the Annual General Meetings (AGMs) is among the developments that the business actors witnessed during the time (Milliken 72). The recommendations would make managers more accountable to the stakeholders. Companies expected investors to continue capitalizing in their companies. As a result, it was critical to establish ways of proving that the companies were protecting their interests. Corporate governance moved from the United Kingdom and the United States to the rest of the world. Many other countries, including the developing ones, have adopted the idea as they attract foreign investment capital (Milliken 73). The King Committee in South Africa is an example of the development in Africa.
The corporate governance idea gained importance in the wake of the 21st century. For instance, the United States introduced the Sarbanes-Oxley Act 2002 to prevent violations of corporate governance. Recent efforts include the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (Milliken 73). The OECD Principles of Corporate Governance is the source of the global framework for this leadership concept. The principles identify some aspects including: “the rights and equitable treatment of shareholders; the role of stakeholders; disclosure and transparency; and the responsibilities of the board of directors” (Milliken 74). The guidelines have become accepted globally as the basis for the development of best practices in corporate governance. The ideologies are used to analyze the corporate governance practice in many countries (Milliken 74). They also play a role in improving governance and ethical practice in companies within various jurisdictions. There are four pillars of governance that the modern business and financial practices should use in creating their practices: “(1) responsibility; (2) accountability; (3) transparency, and (4) fairness” (Milliken 74). Companies that follow the principles continue to create ethical practice and better relationships within and with the outside world.
Contribution of Governance Approaches to Ethical Nature of Corporate Organizations
The corporate governance topic continues to attract attention from various fields, including economics and finance. Commercial organizations are encouraged to implement sound corporate governance systems as a part of the effort to achieve corporate responsibility. The structure informs the relationship between the management and stakeholders of the company (Gebba 23). Therefore, the concept has become significant in the recent decades in the efforts to protect the interests of stakeholders, while ensuring that the organization is efficient and sustainable. The corporate governance practices have various components and categories that reveal the nature of best practices. The ownership structure is one of them and focuses on the activities of the directors and relevant committees (Gebba 31). However, this approach alone does not ensure the effectiveness of corporate governance. Therefore, the component should hold together the four principles of corporate governance, which determines ethical practice.
Companies should have some characteristics to fulfill the corporate governance requirement. The concept defines business organizations that have accountability, responsibility, and transparency. The management should satisfy the duty of meeting the goals of the firm. However, there should be the input of the board of directors and the audit committee because they have an obligation to the stakeholders, especially the investors. Therefore, corporate governance relates to ethics and morals as long as the companies follow the globally acceptable guidelines (Trong Tuan 548). Firms that fulfill the requirements also rate highly in ethical behaviors.
Experts consider businesses as principled if they can effectively balance the pursuance of profits and achievement of corporate social responsibility. From this perspective, standards and morals tend to vary from one culture and region to another. For example, in the Middle East and North Africa (MENA) region, 85% of businesses are small- or medium-sized enterprises (SMEs). The firms are also family-owned enterprises (FOEs), meaning that they are not keen on corporate governance practices (ElGammal et al. 274). However, it does not suggest that businesses do not follow ethical guidelines. Therefore, while corporate governance relates to ethical standards, the two are not mutually exclusive.
Effective corporate governance practices are directly associated with the economic performance of a company because they reveal the commitment of the management to the interests of the stakeholders. Therefore, such companies tend to attract investment since they improve organization, corporate efficiency, and reduce risk (ElGammal et al. 274). The evidence is available in various sectors, including banking and financial services sectors, which continue to adopt the corporate governance practices to gain financing. The guidelines reveal a high level of commitment to responsibility and accountability, hence, ethical practice. Corporate responsibility is the basis for the commonly known ethical behavior, corporate social responsibility, a company-wide strategy defining its contribution back to society. Corporations that have sound corporate governance are expected to utilize available resources ethically. They contribute to sustainable development because of the benefits accrued to the investors, including social, economic and environmental. Corporate governance relates to corporate social responsibility, making it a vital factor in the ethical nature of business organizations (ElGammal et al. 274). Companies with sound structure of leadership are also ethical.
Corporate governance and social responsibility are connected to business ethics. Gallego-Alvarez et al. explore the role of the two concepts in building an ethical business (1709). The principles form the foundation for the development of corporate ethical practices as they define the internal and external relations of the management and other actors in the industry. Additionally, it is the ethical guidelines emanating from corporate governance that lead to the management implementation of sound corporate social responsibility. The way the corporations are controlled and directed is evident during the global financial crisis. Corporate governance was to blame for many of the failures (ElGammal et al. 275). The purpose of the approach in ethical practice emerged due to the collapse of the management to protect the interests of the stakeholders. While there could have been other contributing factors, failure of the administration led to the crisis and became the rationale for the creation of new laws such as the Sarbanes-Oxley Act 2002, the Dodd-Frank Wall Street Reform, and Consumer Protection Act 2010. Therefore, the goal of the statutes is to improve corporate governance and ethics.
Activists recognize the importance of leadership in achieving ethical practice in business. They are concerned about improving corporate processes and implementing the guidelines that make the agent more responsible and accountable. Since the Ethical Tea Partnership in 1997, interest groups continue to play a role in ensuring that businesses in various sectors operate ethically. The organization has been working with tea producers and companies to guarantee sustainability. Corporate governance is at the core of such initiatives because they are meant to guarantee that managers are working responsibly to make sure that there are returns on investment (Morgan 5). From this perspective, the management of the company is at the core of increasing ethical behavior and corporate social responsibility in firms that could have avoided the goal without the persuasion.
Many corporations are facing ethical challenges, especially balancing profitability and the interests of the investors. It is the reason for the increasing conflicts between the management and other stakeholders. In India, such incidents are evident in declining assets under control, primarily because of the collapse in oil prices. Despite the efforts to recover from this issue, the effects indicate challenges in the responsible management of involved companies. Business organizations and activists are making efforts to reform the ethical environment, and the beginning step should be the implementation of the corporate governance principles (ElGammal et al. 277). Companies expect stakeholders to continue investing in the business. As a result, they have the responsibility of ensuring that the resources are used responsibly to benefit the company and the stakeholders.
Corporate governance is one of the most difficult concepts to define, but its role in organizations makes it relevant in practice. Companies have different interests that the management should meet. Some of these interests conflict, but sound corporate governance guides the best practice in the process. The concept has developed since the 20th century to gain the current nature as used in the 21st century. While the idea of corporate governance does not mean the same thing as ethical behavior in business, it plays a critical role in the moral nature of companies. Managers in firms with sound practices operate ethically and responsibly. They work effectively to ensure that they meet the needs and interests of various stakeholders. Corporate governance is at the core of preventing the future financial crisis that emanates from irresponsible business practices.