Ext. Exam. Question Bank: Corporate Governance1. What have been the main influences on the development of corporate governance codes and guidelines?2. What is corporate governance? Describe briefly the effects of Corporate Governance on the business and financial markets as a whole.

Ans. Corporate governance comprises of two words, Corporate and Governance.

Corporate A corporation is an organization created (incorporated) by a group of shareholders who have ownership of the corporation.

The elected board of directors appoints and oversees management of the corporation.Governance Oxford English dictionary defines governance "as the act, manner, fact or function of governing sway control.

The word has Latin origins that suggest the notion of steering". It deals with the processes and systems by which an organization or society operates.

Governance can be used with reference to all kind of organizational structure e.g. Ngo not for profit organization Municipal corporation /gram panchayat Central/state government Partnership firm, etc.Corporate governance broadly refers to the mechanisms, processes and relations by which corporations are controlled and directed. Purpose of corporate governance is to have a demonstrable IMPACT on a corporations FINANCIAL PERFORMANCE.

Governance structures identify the distribution of rights and responsibilities among different participants in the corporation, such as, the board of directors, Managers, Shareholders, Creditors, Auditors, regulators, and other stakeholders and include the rules and procedures for making decisions in corporate affairs.

Effects of CG

provides proper inducement to the owners as well as managers to achieve objectives that are in THE INTERESTS OF INVESTORS and the ORGANIZATION

ensures improved performance -corporate success, and sustainability

lowers the Capital Cost (interest rates on loans)

creates better access to finance -Positively impact the Share Price, thus enhancing investor confidence and attracting investment

minimizes wastages, corruption, risks of corporate crisis and scandals, and mismanagement

Employees become accountable to the Management

The Management becomes accountable to the Board of Directors

The Board of Directors becomes accountable to the Investors and the Community

Protects Shareholders Rights

Treats all shareholders including minorities equitably

Provides effective redress for violations

Ensures timely, accurate disclosure on all material matters, including the financial situation, Performance, ownership and corporate governance

Procedures and structures are in place so as to minimize, or avoid completely conflicts of interest

Independent Directors and Advisers i.e. free from the influence of others

Independent, totally unrelated Auditors free from influence of the Directors and The Management

help to ensure that adequate and appropriate system of internal controls operates hence the assets may be safeguarded

prevent any single individual having too powerful an influence

help to ensure that the company is managed in the best interest of the investors

Establish a framework of sound relationship between the companys management, board of directors, investors and all stakeholders

Shapes the growth and future of capital market & economy.

Instrument of investors protection.

Protecting the interest of Shareholders and all other stakeholder.

Contributes to the efficiency of the business enterprise.

Creation of wealth.

Enables firm to compete internationally in sustained way.

Keeps an eye on the issues of insider training

Strengthen management oversight functions and accountability.

Balance skills, experience and independence on the board appropriate to the nature and extent of company operations.

Establish a code to ensure integrity.

Safeguard the integrity of company reporting.

Risk management and internal control.

Disclosure of all relevant and material matters.

Recognition and preservation of needs of shareholders.

3. Critically discuss whether it would be desirable to have one model of corporate governance applicable to all countries.4. Describe Roles of Audit Committee, Compensation Committee and Nominating & Governing Committee.

Ans. Not all matters are deliberated by the full board. Some are delegated to subcommittees. Committees may be standing or ad hoc, depending on the issue at hand. All boards are required to have -audit committee, compensation committee, nominating and governing committee. On important matters, the recommendations of the committees are brought before the full board for a vote.

ROLE OF AUDIT COMMITTE

Oversight of financial reporting and disclosure Monitor the choice of accounting policies Oversight of external auditor Oversight of regulatory compliance Monitor internal control processes Oversight of performance of internal audit function Discuss risk management policiesExample of Best Practice about the Audit Committee engagement-Audit committees meet on average 7 times per year, for 3.2 hours eachROLE OF COMPENSATION COMMITTEE

Set the compensation for the CEO

Advise the CEO on compensation for other executive officers

Set performance-related goals for the CEO

Determine the appropriate structure of compensation

Monitor the performance of the CEO relative to targets

Hire consultants as necessary

Example of Best Practice about the Compensation Committee engagement -Compensation committees meet on average 5 times per year, for 2.4 hours eachROLE OF NOMINATING & GOVERNING COMMITTEE

Identification of qualified individuals to serve on the board

Selection of nominees to be voted on by shareholders

Hiring consultants as necessary

Determine governance standards for the company

Manage the board evaluation process

Manage the CEO evaluation process

Example of Best Practice about the Nominating and governance Committee engagement - Nominating and governance committees meet on average 4 times per year, for 1.9 hours each

5. Discuss the specific lessons learnt from various Corporate Scandals. Ans. Lessons:-1. Some Corporate Executives Will Do Almost Anything~ To Meet Earnings expectations, AND To Keep the Firms Share Price Stable or Rising2. There is a need for the Top Management to Set the Ethical Climate in a Firm

3. Auditors and their Clients Can Get Too Close ~ An Auditors independence is a necessary condition for a meaningful audit4. GAAP is subject to significant management discretion

5. There is No Way For Accounting Standards to stop Fraud (Auditors and SEC/SEBI may be able to make some progress in reducing the fraud

6. Over-reliance on a single amount -Earnings Per Share Can be a Disaster7.Excessive Leverage is usually a High-Risk Strategy (Lehman's demise is a case study in the dangers of excessive leverage

8.For Financial Institutions Adequate Liquidity is A Must (Case of Washington Mutual- Run on The Bank)..The credit markets were virtually frozen at that time following the bankruptcy of Lehman Brothers, and the near-collapse of AIG, Fannie Mae and Freddie Mac

9.Fraud Never Pays-With former WorldCom CEO Bernard Ebbers serving a 25-year jail sentence for fraud and conspiracy as a result of the company's fraudulent accounting and financial reporting, the lesson here is that fraud never pays

10 Key Lesson for Investors from the Enron Bankruptcy-If you can't understand it, don't invest in it. Warren Buffets maxim is, "Never invest in a business you cannot understand.

11. Key Lessons for Investors from the Barings Bank Scandal-.. The downfall of Barings Bank was brought about by the actions of one man- Nick Leeson Nick was able to cover up the losses for number of months What does it imply..??~ Lack of Internal Controls~ Lack of effective supervision by experienced staff with good understanding of the process and procedures12. Key Lesson from Parmalat, Madoff and similar scandals..What may happen if the involvement of investors is suppressed

Elaborated points Some Corporate Executives will do almost anything to meet 'earnings expectations, and to Keep the Firms Share Price Stable or Rising. Often the goal is one of personal enrichment through the executives exercise of options and the sale of company stocks.

C level Executives must establish and demand te integrity of the firms disclosures- Both Financial and Non Financial

An Auditors independence is a necessary condition for a meaningful audit. Case: Arthur Andersen---Even though the External Auditing firm may not have fraudulent intentions, close relationships between the Auditor and the Client Firm cause the Auditors overlooking the obvious. The Firms must make their earning more transparent.

No matter how good or how effective the accounting principles are, there is no way for the Accounting Standards to stop Fraud.

Financial Statements are only a part of the information investors need to evaluate a companys Past, Present and Future.

Excessive Leverage is usually a High-Risk Strategy. ~Lehman's demise is a case study in the dangers of excessive leverage. Lehman's big push into the subprime mortgage market initially provided stellar returns, as it reported record profits every year from 2005 to 2007. But by 2007. Its leverage was reaching dangerously high levels. In that year, Lehman was the leading underwriter of mortgage-backed securities on Wall Street, accumulating an $85 billion portfolio. The ratio of total assets to shareholders equity was 31 in 2007, which meant that each dollar of assets on its balance sheet was backed by only three cents in equity. For Financial Institutions Adequate Liquidity is A Must (Case of Washington Mutual- Run on The Bank).The credit markets were virtually frozen at that time following the bankruptcy of Lehman Brothers, and the near-collapse of AIG, Fannie Mae and Freddie Mac. Massive Deposit Outflows- Often cash is a drag in a bull market, but cash is king when times are tough. Therefore, it makes sense to have adequate liquidity at all times, in order to meet contingencies and unexpected expenses.

With former WorldCom CEO Bernard Ebbers serving a 25-year jail sentence for fraud and conspiracy as a result of the company's fraudulent accounting and financial reporting, the lesson here is that fraud never pays. WorldCom was by no means the only company to indulge in accounting fraud other perpetrators to be caught in 2002 alone included Tyco, Enron and Adelphia Communications. There have also been numerous other forms of corporate fraud in recent years, from multi-billion Ponzi schemes run by Bernie Madoff and Allen Stanford to insider trading and options-backdating scandals. Many of the executives who were involved in these frauds ended up serving time in jail and/or paying very stiff fines. Key Lesson for Investors from the Enron Bankruptcy-..If you can't understand it, don't invest in it Warren Buffets maxim is, "Never invest in a business you cannot understand. Enron succeeded in deceiving the "smart money," such as pension funds and other institutional investors for years, through Lack of Transparency, and Accounting Gimmickry.6. List the SEBI mandate regarding the Audit Committee and its Role, and the criteria to be independent director.Ans. SEBI mandate regarding the Audit Committee and its RoleA Sub-Committee of Board of Directors of the Company constituted under provisions of Listing agreement and Companies Act, 2013

Members should be Financially Literate Chairman of Audit Committee to be Independent Company Secretary to be the Secretary to the CommitteeAudit Committee Meeting Frequency: Four Times a Year with Maximum Gap of 4 monthsRole Overview Financials Statements Quarterly and Annual Review performance of the company Appoint & re-appoint Statutory and Internal Auditors Approval of appointment of CFOCriteria to be independent director. No pecuniary material relationship with Company, Promoters, Directors, Senior Management, Holding, subsidiary or associate Company Is not a relative of any of the Directors Is/was not an employee of the company or was partner of audit firm or legal firm which has pecuniary interest in the past 3 years Is not a substantial shareholder, i.e. not more than 2% shareholding Is at least 21 years oldStrength of Board of Directors If Chairman is Non - Executive Director, then 1/3 of Directors should be Independent Directors. If Chairman is Executive Director, then the Directors should be Independent Directors. If Chairman is Non - Executive promoter Director, then also the Directors of the Board should be Independent DirectorsBoard of DirectorsBoard Meeting Frequency: Four times a year Maximum gap of Four Months onlyNo. of Directorships/Chairmanships: Member of not more than 10 Committees and cannot be Chairman of more than 5 committeesCode of Conduct: Board shall draft a Code of Conduct and shall be applicable to all Board Members and Senior Management It shall be posted on the Website of the Company7. What are the main problems that may arise in a principal-agent relationship and how might these be dealt with.Ans. MAIN PROBLEMS:

The principal agent problem arises when one party (agent) agrees to work in favor of another party (principal) in return for some incentives. Such an agreement may incur huge costs for the agent, thereby leading to the problems of moral hazard and conflict of interest.

Moral Hazard occurs when the agent acts on behalf of the principal, and is supposed to meet the principals goals. The objectives of the agent and principal however are different. The principal cannot easily determine whether the agents actions are actually self-interested misbehavior or not. Thus moral hazard characterizes many principle-agent situations.

Conflict of interest occurs when costs incurred by agent start rising and agent presumes it will be an unprofitable relationship for him. Owing to the costs incurred, the agent might begin to pursue his own agenda and ignore the best interest of the principal, thereby causing the principal agent problem to occur.

DEALING WITH THE PROBLEMS:

There are 3 contractual forms to solve the agent-principal problem:

1. Incentive

2. Monitoring

3. Co-operative

1. INCENTIVE: As agents effort is not public information and it is costly and difficult to monitor actual effort of each salesperson. The best solution is payment based on the outcome determined by certain conditions as follows:

i. When the agent is risk neutral the optimal contract is one in which the agent bears all risks, making a fixed payment to principal.

ii. When the agent is risk averse and effort averse, the second best solution is efficient-risk sharing. It forces the agent to bear some risk and his payment depends, to some extent, on the risky outcome.

2. MONITORING: Since the source of principal-agent problem is information asymmetry, a natural remedy is to invest resources into monitoring of actions. Monitoring leads to complicated hierarchical and bureaucratic organizational culture. Monitoring creates additional authority that eventually leads to complicated bureaucracy system bound with mutual rules. This system is inefficient to react quickly to changes in its operating environment.

3. CO-OPERATIVE: This is possible only when there are potential synergies for working in a team. Team members must either be acquired at low cost (to the organization), the relevant specific knowledge for making good decisions. The organization must be able to control the free-rider problems of teams at a relatively low cost. The team payments must be done based on:

a. Profit sharing

b. Forcing contract

c. efficiency wages

8. What functions does a board perform and how does this contribute to the corporate governance of the company?

Ans.

The board should exercise compelling and relentless leadership and should not underestimate the power of leading by example - evidenced by high levels of visibility and integrity, strong communications, and demanding expectations. This leadership should be clear to ALL within the organization, as well as shareholders and other stakeholders Boardroom Behaviours A report prepared for Sir David Walker by the Institute of Chartered Secretaries and Administrators , UKJune 2009 Much of the research on boards ultimately touches on the question what is the role of the board? Possible answers range from boards being simply legal necessities, to their playing an active part in the overall management and control of the corporation.

Role Of the Board from a financial perspective:

Duty to maintain proper accounting records

Periodic reporting of financial position, performance

Establishing, monitoring proper internal controls

Ensuring proper external controls and audit

Skills, knowledge required by directors

Director Responsibilities:

The basic responsibility of the Directors is to exercise their business judgment to act in what they reasonably believe to be in the best interests of the Company and its shareowners. In discharging that obligation, directors should be entitled to rely on the honesty and integrity of the Companys senior executives and its outside advisors and auditors. In furtherance of its responsibilities, the Board of Directors will:

1. Review, evaluate and approve, on a regular basis, long-range plans for the Company.

2. Review, evaluate and approve the Companys budget and forecasts.

3. Review, evaluate and approve major resource allocations and capital investments.

4. Review the financial and operating results of the Company.

5. Review, evaluate and approve the overall corporate organizational structure, the assignment of senior management responsibilities and plans for senior management development and succession.

6. Review, evaluate and approve compensation strategy as it relates to senior management of the Company.

7. Adopt, implement and monitor compliance with the Companys Code of Conduct.

8. Review periodically the Companys corporate objectives and policies relating to social responsibility.

9. Review and assess the effectiveness of the Companys policies and practices with respect to risk assessment and risk management.

9. Describe the elements of Good Board Practices and Procedures.10. In what ways might Stakeholders' conflict with each other?11. What corporate governance mechanisms might help with representing the views of stakeholder/12. Why has the influence of institutional investors grown so much in recent years?13. What are the SEBI Act 49 requirements in respect of 'Subsidiary Companies', 'CEO Certification and Report on Corporate Governance', and 'Disclosures'?

Ans. (Extract from Session 6 PPT)

Subsidiary

Two classesi) A Material Subsidiary - if any of the following conditions are satisfied In which the current/proposed Investment of the Company exceeds 20% of its consolidated net worth as per the last audited balance sheet; or

Which have generated at least 20% of the consolidated income of the Company during the previous financial year

ii) A Material Non-Listed Indian Subsidiary : A Material Subsidiary which is incorporated in India and is not listed on the Indian Stock Exchanges

At least one independent director of Holding company to be in subsidiary company

The Audit Committee of the Holding Company must examine the financial statements of the unlisted subsidiary Company, in particular, the investments made by the latter

The Minutes of the Board Meetings of the Unlisted Subsidiary Companies shall be placed before the Board of the Listed Holding Company

The management must place before the Board of Holding Company a report of all Significant Transactions and Arrangements entered into by the unlisted subsidiary company

(Significant transaction or arrangement means any individual transaction/arrangement that exceeds or is likely to exceed 10% of the total revenues/expenses/assets/liabilities, as the case may be, of the material unlisted subsidiary for the immediately preceding accounting year.)

Disclosures

The philosophy of disclosure in the securities markets is premised on the idea that securities represent a bundle of rights that are not visible to a potential buyer of securities and that

The buyer must know the nature of the bundle of rights before investing.

Disclosure also reduces the possibility of wrongdoing

Even if a disclosure is not read by anyone, the fact that something needs to be disclosed provides a good prophylactic against wrongdoing

The idiom that sunlight is the best disinfectant succinctly describes a whole philosophy in the securities market

Basis of Related Party Transactions

( Definition of Related Party Transactions - A business deal or arrangement between two parties who are joined by a special relationship prior to the deal.For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform renovations to the corporation's offices, would be deemed a related-party transaction. Disclosure of Accounting Treatment

Board Disclosure Risk Management

Proceeds from Public, Rights, Preferential Issues

Remuneration of Directors

Management

Shareholder

CEO/CFO Certification

CEO- Managing Director and CFO Director/ Head Finance shall submit a certificate to the Board on:

Reviewed financials statement and it contains no untrue or misleading statements

Financial Statements present true and fair view

They accept responsibility for establishing and maintaining Internal control for financial report and rectifying deficiencies, if any.

14. What are the mandatory requirements relating to the minimum information that must be made available to the Board of Governors in accordance with the provisions of clause 49A of the SEBI Act (2003)?1. Annual operating plans and budgets and any updates.

2. Capital budgets and any updates.

3. Quarterly results for the company and its operating divisions or business segments.

4. Minutes of meetings of audit committee and other committees of the board.

5. The information on recruitment and remuneration of senior officers just below the board level, includingappointment or removal of Chief Financial Officer and the Company Secretary.

6. Show cause, demand, prosecution notices and penalty notices which are materially important

7. Fatal or serious accidents, dangerous occurrences, any material effluent or pollution problems.

8. Any material default in financial obligations to and by the company, or substantial non-payment for goodssold by the company.

9. Any issue, which involves possible public or product liability claims of substantial nature, including any judgment or order which, may have passed structure on the conduct of the company or taken an adverse view regarding another enterprise that can have negative implications on the company.

10. Details of any joint venture or collaboration agreement.

11. Transactions that involve substantial payment towards goodwill, brand equity, or intellectual property.

12. Significant labour problems and their proposed solutions. Any significant development in Human Resources/Industrial Relations front like signing of wage agreement, implementation of Voluntary Retirement Scheme etc.

13. Sale of material nature, of investments, subsidiaries, assets, which is not in normal course of business.

14. Quarterly details of foreign exchange exposures and the steps taken by management to limit the risks ofadverse exchange rate movement, if material.

15. Non-compliance of any regulatory, statutory or listing requirements and shareholders service such as non-payment of dividend, delay in share transfer etc.

16. The law does not require any agenda for meetings of the Board [Abnash Kaur v. Lord Krishan Sugar MillsLtd. (1974) 44 Com Cases 390, 413 (Del)].

17. Board of directors can transact business even without a formal agenda [Sunil Dev v. Delhi & District Cricket Association, (1994) 80 Com Cases 174 (Del)].

18. It is not necessary that an agenda for directors meeting should be specified [Maharashtra Power Development Corpn Ltd. v. Dabhol Power Co., (2004) 120 Com Cases 560 (Bom)].

15. What are the main developments in Corporate Governance Codes?

The First Phase of Indias Corporate Governance Reforms: 1996-2008 Indias corporate governance reform efforts were initiated by corporate industry groups, many of which were instrumental in advocating for and drafting corporate governance guidelines. Following vigorous advocacy by industry groups, SEBI proceeded to adopt considerable corporate governance reforms. The first phase of Indias corporate governance reforms were aimed at making boards and audit committees more independent, powerful and focused monitors of management as well as aiding shareholders, including institutional and foreign investors, in monitoring management.9 These reform efforts were channeled through a number of different paths with both SEBI and the MCA playing important roles.

SEBI-appointed committees and the adoption of Clause 49 Shortly after introduction of the CII Code, SEBI appointed the Committee on Corporate Governance (the Birla Committee). In 1999, the Birla Committee submitted a report to SEBI to promote and raise the standard of Corporate Governance for listed companies.12 The Birla Committees recommendations were primarily focused on two fundamental goalsimproving the function and structure of company boards and increasing disclosure to shareholders. With respect to company boards, the committee made specific recommendations regarding board representation and independence that have persisted to date in Clause 49.13 The committee also recognized the importance of audit committees and made many specific recommendations regarding the function and constitution of board audit committees.

The Second Phase of Reform: Corporate Governance: After Satyam Indias corporate community experienced a significant shock in January 2009 with damaging revelations about board failure and colossal fraud in the financials of Satyam. The Satyam scandal also served as a catalyst for the Indian government to rethink the corporate governance, disclosure, accountability and enforcement mechanisms in place.

MCA actions Inspired by industry recommendations, including the influential CII recommendations, in late 2009 the MCA released a set of voluntary guidelines for corporate governance. The Voluntary Guidelines address a myriad of corporate governance matters including:

independence of the boards of directors;

responsibilities of the board, the audit committee, auditors, secretarial audits; and

mechanisms to encourage and protect whistleblowing.

Important provisions include:

i. Issuance of a formal appointment letter to directors.

ii. Separation of the office of chairman and the CEO.

iii. Institution of a nomination committee for selection of directors.

iv. Limiting the number of companies in which an individual can become a director.

v. Tenure and remuneration of directors.

vi. Training of directors.

vii. Performance evaluation of directors.

viii. Additional provisions for statutory auditors.

SEBI actions In September 2009 the SEBI Committee on Disclosure and Accounting Standards issued a discussion paper that considered proposals for:

appointment of the chief financial officer (CFO) by the audit committee after assessing the qualifications, experience and background of the candidate;

rotation of audit partners every five years;

voluntary adoption of International Financial Reporting Standards (IFRS);

interim disclosure of balance sheets (audited figures of major heads) on a half-yearly basis

16. What are the main sub-committees of the board and what role does each of these sub-committees play?

17. Describe Salient Features of Anglo-American-, German-, Japanese-, and Indian Corporate Governance Models

Ans. Anglo American Model

This model is also called an Anglo-Saxon model and is used as basis of corporate governance in U.S.A, U.K, Canada, Australia, and some common wealth countries The shareholders appoint directors who in turn appoint the managers to manage the businessThus there is separation of ownership and control The board usually consist of executive directors and few independent directorsThe board often has limited ownership stakes in the companyMoreover, a single individual holds both the position of CEO and chairman of the boardThe Anglo-American Model relies on effective communication between shareholders, board and management with all important decisions taken after getting approval of shareholders (by voting) GERMAN Model

This is also called as 2 tier board model as there are 2 boards viz. The supervisory board and the management board. It is used in countries like Germany, Holland, France, etc. Usually a large majority of shareholders are banks and financial institutionsThe shareholder can appoint only 50% of members to constitute the supervisory boardThe rest is appointed by employees and labor unions

Japanese Model

This model is also called as the business network model, usually shareholders are banks/financial institutions, large family shareholders, corporate with cross-shareholding There is supervisory board which is made up of board of directors and a president, who are jointly appointed by shareholder and banks/financial institutions. This is rejection of the Japanese keiretsu- a form of cultural relationship among family controlled corporate and groups of complex interlocking business relationship, where cross shareholding is common most of the directors are heads of different divisions of the company. Outside director or independent directors are rarely found of the board

Indian Model

The model of corporate governances found in India is a mix of the Anglo-American and German models. This is because in India, there are three types of Corporation viz. private companies, public companies and public sectors undertakings (which includes statutory companies, government companies, banks and other kinds of financial institutions). Each of this corporation have a distinct pattern of shareholding. For e.g. in case of companies, the promoter and his family have almost complete control over the company. They depend less on outside equity capital. Hence in private companies the German model of corporate governance is followed.

18. What would Good Corporate Governance entail, and what would it achieve?

19. How are different theories of corporate governance more appropriate to different types of ownership structures?Stewardship theory :

It sees a strong relationship between managers and the success of the firm, and therefore the stewards protect and maximise shareholder wealth through firm performance. A steward who improves performance successfully, satisfies most stakeholder groups in an organization, when these groups have interests that are well served by increasing organisational wealth (Davis, Schoorman & Donaldson 1997). When the position of the CEO and Chairman is held by a single person, the fate of the organization and the power to determine strategy is the responsibility of a single person. Thus the focus of stewardship theory is on structures that facilitate and empower rather than monitor and control (Davis, Schoorman & Donaldson 1997). Therefore stewardship theory takes a more relaxed view of the separation of the role of chairman and CEO, and supports appointment of a single person for the position of chairman and CEO and a majority of specialist executive directors rather than non-executive directors (Clarke 2004).

Social Contract Theory:

It sees society as a series of social contracts between members of society and society itself (Gray, Owen & Adams 1996). There is a school of thought which sees social responsibility as a contractual obligation the firm owes to society (Donaldson 1983). An integrated social contract theory was developed by Donaldson and Dunfee (1999) as a way for managers make ethical decision making, which refers to macrosocial and microsocial contracts. The former refers to the communities and the expectation from the business to provide support to the local community, and the latter refers to a specific form of involvement.

Legitimacy Theory:

Traditionally profit maximization was viewed as a measure of corporate performance. But according to the legitimacy theory, profit is viewed as an all inclusive measure of organizational legitimacy (Ramanathan 1976). The emphasis of legitimacy theory is that an organization must consider the rights of the public at large, not merely the rights of the investors. Failure to comply with societal expectations may result in sanctions being imposed in the form of restrictions on the firm's operations, resources and demand for its products. Much empirical research has used legitimacy theory to study social and environmental reporting, and proposes a relationship between corporate disclosures and community expectations (Deegan 2004).

Political Theory:

Political theory brings the approach of developing voting support from shareholders, rather by purchasing voting power. Hence having a political influence in corporate governance may direct corporate governance within the organization. Public interest is much reserved as the government participates in corporate decision making, taking into consideration cultural challenges (Pound, 1983). The political model highlights the allocation of corporate power, profits and privileges are determined via the governments favor.

Resource Dependency Theory:

According to the resource dependency rule, the directors bring resources such as information, skills, key constituents (suppliers, buyers, public policy decision makers, social groups) and legitimacy that will reduce uncertainty (Gales & Kesner, 1994). Thus, Hillman et al. (2000) consider the potential results of connecting the firm with external environmental factors and reducing uncertainty is decrease the transaction cost associated with external association. This theory supports the appointment of directors to multiple boards because of their opportunities to gather information and network in various ways.

Stakeholder Theory:

With an original view of the firm the shareholder is the only one recognized by business law in most countries because they are the owners of the companies. In view of this, the firm has a fiduciary duty to maximize their returns and put their needs first. In more recent business models, the institution converts the inputs of investors, employees, and suppliers into forms that are saleable to customers, hence returns back to its shareholders. This model addresses the needs of investors, employers, suppliers and customers. Pertaining to the scenario above, stakeholder theory argues that the parties involved should include governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees and the general public. In some scenarios competitors and prospective clients can be regarded as stakeholders to help improve business efficiency in the market place.

Agency theory:

The agency model assumes that individuals have access to complete information and investors possess significant knowledge of whether or not governance activities conform to their preferences and the board has knowledge of investors preferences (Smallman, 2004). Therefore according to the view of the agency theorists, an efficient market is considered a solution to mitigate the agency problem, which includes an efficient market for corporate control, management labour and corporate information (Clarke, 2004). According to Johanson and Ostergen (2010) even though agency theory provides a valuable insight into corporate governance, its applies to countries in the Anglo-Saxon model of governance as in Malaysia.

20. Describe briefly the Agency and Stewardship theories of Corporate Governance.AGENCY THEORY

Agency theory relative to corporate governance assumes a two-tier form of firm control: managers and owners. Agency theory holds that there will be some friction and mistrust between these two groups. The basic structure of the corporation, therefore, is the web of contractual relations among different interest groups with a stake in the company.

Features

In general, there are three sets of interest groups within the firm. Managers, stockholders and creditors (such as banks). Stockholders often have conflicts with both banks and managers, since their general priorities are different. Managers seek quick profits that increase their own wealth, power and reputation, while shareholders are more interested in slow and steady growth over time.

Function

The purpose of agency theory is to identify points of conflict among corporate interest groups. Banks want to reduce risk while shareholders want to reasonably maximize profits. Managers are even more risky with profit maximization, since their own careers are based on the ability to turn profits to then show the board. The fact that modern corporations are based on these relations creates costs in that each group is trying to control the others.

Costs

One of the major insights of agency theory is the concept of costs of maintaining the division of labor among credit holders, shareholders and managers. Managers have the advantage of information, since they know the firm close up. They can use this to enhance their own reputations at the expense of shareholders. Limiting the control of managers itself contains costs (such as reduced profits), while profit seeking in risky ventures might alienate banks and other financial institutions. Monitoring and limiting managers itself contains sometimes substantial costs to the firm.

Significance

The agency model of corporate governance holds that firms are basically units of conflict rather than unitary, profit-seeking machines. This conflict is not aberrant but built directly into the structure of modern corporations.

Effects

It is possible, if one accepts the premises of agency theory, that corporations are actually groups of connected fiefs. Each fief has its own specific interest and culture and views the purpose of the firm differently. In analyzing the function of a corporation, one can assume that managers will behave in a way to maximize their own profit and reputation, even at the expense of shareholders. One might even understand the manager's role as one of institutionalized deceit, where the asymmetry of knowledge permits managers to operate with almost total independence.

Stewardship Theory

Stewardship theory, however, rejects self-interest.

Motivation

For stewardship theory, managers seek other ends besides financial ones. These include a sense of worth, altruism, a good reputation, a job well done, a feeling of satisfaction and a sense of purpose. The stewardship theory holds that managers inherently seek to do a good job, maximize company profits and bring good returns to stockholders. They do not necessarily do this for their own financial interest, but because they feel a strong duty to the firm.

The stewardship theory holds that managers inherently seek to do a good job.

Identification

stewardship theory holds that individuals in management positions do not primarily consider themselves as isolated individuals. Instead, they consider themselves part of the firm. Managers, according to stewardship theory, merge their ego and sense of worth with the reputation of the firm.

Policies

If a firm adopts a stewardship mode of governance, certain policies naturally follow. Firms will spell out in detail the roles and expectations of managers. These expectations will be highly goal-oriented and designed to evoke the manager's sense of ability and worth. Stewardship theory advocates managers who are free to pursue their own goals. It naturally follows from this that managers are naturally "company men" who will put the firm ahead of their own ends. Freedom will be used for the good of the firm.

Consequences

The consequences of stewardship theory revolve around the sense that the individualistic agency theory is overdrawn. Trust, all other things being equal, is justified between managers and board members. In situations where the CEO is not the chairman of the board, the board can rest assured that a long-term CEO will seek primarily to be a good manager, not a rich man. Alternatively, having a CEO who is also chairman is not a problem, since there is no good reason that he will use that position to enrich himself at the expense of the firm. Put differently, stewardship theory holds that managers do want to be richly rewarded for their efforts, but that no manager wants this to be at the expense of the firm.