Corporate Governance – An Economic Perspective by Rupanjana De 2

8/7/2019 Corporate Governance – An Economic Perspective by Rupanjana De 2

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Corporate Governance – An Economic PerspectiRupanjana De, ACS, Director, Nandi Resources Generation Technology P

Kolkata.

e-mail :

[email protected]

Corporate Governance does not start and end with a set of rules, guidel

policies to be complied with but has wider implications and impact on the e

of the nation. How, is what this write up seeks to explain.

"In a more globalized, interconnected and competitive world,

the way that environmental, social and corporate governance

issues are managed is part of companies’ overall management

quality needed to compete successfully Companies that

while analyzing good corporate governance as an

economic efficiency.

Economic theories of Corporate Governan



quality needed to compete successfully. Companies that p

A r t i c l e

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possible manner in the interest of shareholders. However, due

to this separation of ownership and control, shareholders who

are the true owners of a company, do not control it, the controlrather lies in the hands of the managers and directors who do

not own the organization. Under this theory, the main problem

in corporate governance is this separation that fuels divergence

of interests and the directors may divert from the profit

maximising aim and be rather interested in maximising their

self interest like increasing their perks and salaries, their

reputation (which may be at the cost of shareholder benefit),

diversion of company assets for personal uses etc. Such adivergence of interest can be the root cause of bad corporate

governance.

While the shareholder theory of corporate governance attaches

supreme importance to the shareholders as owners of the

company, the much wider view presented by the stakeholder

theory takes into account all the formal and informal, written

and unwritten relations of a company viz., creditors, employees,

suppliers, customers, other contractual parties, members of

the society, institutions with various interests like those for

environmental health hazards, governments and so on. This

theory takes a broader notion of corporate governance and

holds companies to be “socially responsible” organisations that

this that we need a mechanism that provides fo

decision making in situations that were not fore

inception of the contract. Such efficient decision maimply efficient use of discretion and accountability

Thus good corporate governance is required to

chances of ex-post opportunistic behaviour by di

managers and divergence of their interest from the

of a company so that investors do not shy away their

in companies due to non-reliance on directors. T

result in a hold-up situation and adversely affect th

It is to check the occurrence of such situationshareholder theory of corporate governance has d

As in the shareholder theory, even in the stakeho

there are chances that all ‘investors’ (meaning all ‘st

here) shy away their investment because they do no

returns on their investment. To take an example, th

a non-optimum investment of employees into

capital of the company, the suppliers may under-i

form of low quality raw-materials and customers

invest by buying less of the company products

creditors may under-invest by unfavourable credit t

underinvestment from distributors may take th

inefficient distribution network and so on. The ba

Corporate Governance – An Economic



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To use the markets for corporate control like take-oversetc.

Shareholder theory vs. Stakeholder theory

Both the shareholder and stakeholder theories of corporate

governance have come in for criticisms. The following

criticisms are often labeled against the shareholder theory:

There is an overemphasized and practically baseless

presumption of strong managers vs. weak shareholders

conflict which has paved the way for all the corporategovernance theories of resolving monitoring and diverse

interest problems. The argument in favour of this is that

widely dispersed ownership in companies is not the

general norm but more like an exception, and it would

be erroneous to think that corporate governance is just

meant for large public listed companies only. Each small

company is a unit in the economy and each make

fractional contribution towards the betterment of theeconomy. After all, the sea is made up of millions and

billions of drops of water. One drop of contaminated

water can bring down the quality of water of the entire

sea. Unlike the widely-held companies where managers

enjoy greater control rights vis-a-vis the shareholders,

The stakeholder theory leaves scope for the managers of a company to take shelter unde

coverage of the term stakeholder to avoid quecompany’s bad results.

The right approach

What follows from the above is that both the

drawbacks, but both equally have benefits. The

theory helps directors and managers fix the target fo

levels to be reached based upon single criteria of

wealth maximisation while the stakeholder theoryavoid underinvestment from a number of business c

and thereby aids long-term growth of the com

ultimately paces up economic growth. However c

the greater economic benefits to the nation, the

theory definitely gains an edge over the sharehol

In order to make the stakeholder theory more suit

stakeholder approach has developed and this new

narrows down the meaning of a stakeholder andonly those parties as stakeholders who have direct f

investment in the company. The contributi

stakeholders are important and go hand in hand

shareholder net wealth. Hence the shareholders hav

Corporate Governance – An Economic Perspective



A r t i c l e

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market for corporate control, managerial stock options, etc.

are some recent developments that are fueled by this idea.

Nonetheless, good corporate governance mechanism is acombination of many things including competition in the

product, capital and labour market, economic efficiency,

and the legal set up. These together provide a systematic

approach to corporate governance. However, the problem

with such a systemic approach is that it is not a very easy

task to develop such a mechanism after taking into

consideration so many aspects.

How bad corporate governance affects the economy

While discussing corporate governance as a contributor to

economic efficiency, it is worthwhile to take up the point

raised by Professors Merritt B. Fox and Michael A. Heller, of

the Columbia Law School in their much referred to study

“Corporate Governance Lessons from Russian Enterprise

Fiascoes” published in the New York University Law Reviewin 2000. In analyzing the connection between economic

efficiency and corporate governance, these researchers took

up the example of Russian economy immediately after its

transition into privatization. Researching into the poor

performance of the Russian corporate sector and the fall of

the firm’s wealth and in case of enterprises

shareholders, distributing the wealth so gained on

basis to them. In their view, companies will corporate governance if they are characterised b

aim of maximising shareholders’ wealth and ma

rata distribution of that wealth amongst the sh

This implies that bad corporate governance in a

micro level might arise from its inability to fulf

or both of these economic functions. While failu

these objectives might be due to a variety of rea

one such reason may be the existing legal set u

contrary to the more popular viewpoint.

These authors have identified seven symptoms

corporations which go in to point towards their ba

governance. Out of these the first five relate to ma

of wealth and the last two relate to pro rata dist

this wealth and according to them these are the s

by which, in their words “loosely constrained incentivised managers cause social welfare loss

seven of which can be identified with poor

governance. Accordingly inability of firms to

wealth may be deduced from the following five

Corporate Governance – An Economic



Does the company secretary fit in to the economic

efficiency theories?

From the above discussion on the point raised by Professors

Fox and Heller, it is easy to link that the company secretary

can make a difference. Non- pro rata distribution of wealth

generated by firms to the shareholders resulting from diversion

of claims of the company by the managers from rightfulclaimants can definitely be put to check by the presence of a

company secretary in the organisation. A company secretary

can ensure that managers do not divert claims of the company

by refusing to give effect to share purchases by outsiders, or

by refusing to accept board directors lawfully elected by such

shareholders, or by issuing shares to insiders against inadequate

consideration and so on. It is the job of the company secretary

to ensure that such malpractices do not occur, and he is the

compliance officer of the company charged with ensuring

proper compliance with all legal requirements. These fall

within the purview of his day to day activities. The company

secretary can therefore be instrumental in effecting pro rata

distribution of residuals generated by a firm and thereby make

his contribution towards the economy. Similarly, the company

secretary may also be instrumental in ensuring that the companyhas a long lasting relation with all its stakeholders and thereby

increase the sustainability of the organisation for greater

economic benefit.

Conclusion

Developing an all-proof framework for efficien

governance that ensures complete legal complian

allocation of resources, optimum level of investm

stakeholders in a company, long-lasting business

and sustained business and economic growth and w

same time ensures that directors and managaccountable to the shareholders is a herculean t

developed, such a corporate governance mechanis

an ideal one. The reason is simple, quite contrary to

belief, corporate governance does not start and end

a set of rules, guidelines and policies to be comp

is much more with much wider implication and goo

governance has its positive impact on the economy

nation. It is not just about directors and manageraccountable to shareholders, or even the wider v

targets the stakeholders as the beneficiaries of good g

It is rather about treating a company as an econo

the minimum and that what it does, does not mere

employees, creditors, investors, competitors, cus

the government, the impact is on the entire eco

economically developing countries like India, this c

gains all the more importance and we are compelthat the rightly planned corporate governance

companies that puts due emphasis on economic d

of the country is the demand of the hour.

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Corporate Governance – An Economic Perspective by Rupanjana De 2