The primary duty, in other words, is to act honestly in good faith, giving all shareholders equal, sufficient and accurate information on all issues that could affect their interests. Directors may not treat a company as though it exists for their personal benefit.
A director, consequently, must not make a secret profit out of dealings with the company. His duty is to disclose any such interests to the board and to abide by their decision as to what is in the company's best interests. Insider trading, that is dealing in the shares of a quoted company, on the basis of privileged, price sensitive information is considered improper in all jurisdictions and is a criminal offence in most (though not all).
A further duty imposed on directors, either by statute or case law, is the duty to exercise reasonable care, diligence and skill in their work on the board. The interpretation of what constitutes such reasonable skill and care varies between countries. A general proposition is that the standard of professionalism now expected of directors, around the world, is significantly higher than a few years ago. Courts will act if fraudulent or negligent behaviour is alleged, or where there seem to be abuses of power by directors: it is not the role of the courts to second guess commercial judgments made by directors, even though by hindsight they have been misguided.
G. Theories of Corporate Governance
The original corporate concept enshrined a philosophical assumption about the nature of man, one that has been reflected in subsequent developments of company law – a view that man is essentially trustworthy, able to act in good faith in the interest of others with integrity and honesty. This is implicit in the fiduciary relationship required of directors. Certainly checks and balances are involved, but only to catch the occasional rogue.
This perspective has been termed stewardship theory (Donaldson and Davis 1988) and is consistent with some behavioural theories; for example with theory Y of Macgregor, whose principal propositions include:
1) that management is responsible for organizing the productive elements – men, machines, materials and money – in the interests of economic ends;
2) that people are not by nature passive or resistant to organizational needs;
3) that the motivation, the potential for development, the readiness to direct behaviour towards organizational goals are all present in people.
However, one of the earliest studies in the field of corporate governance, by Berle and Means in 1932t provided a challenge to the conventional assumptions of stewardship theory. They pointed out that] ownership in large public companies had become separated from management. No shareholder owned significant proportion of the equity capital. The top managers themselves held only very small stakes, if J any. Consequently the shareholders were no longer able to monitor the affairs of the business in which they had invested – they had surrendered their control to management. Moreover, the interests of owners and management was likely to diverge – the former seeking increased corporate worth reflected in share price and dividend stream, the latter in job security, reward packages, and other personal benefits.
Berle and Means contended that managers did not have the same interest and motivation as the owners to make full and efficient use of the corporate assets. Consequently the owners had to introduce other means to ensure an alignment of owners and managers interests. Jensen and Meckling (1976) extended the argument by assessing the agency cost of this alignment. They define the shareholder relationship as one of agency: a contract under which one or more persons (the principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizers there is good reason to believe the agent will not always act in the best interests of the principal.
Such a perception has become the underpinning of agency theory, now an important component of the literature of financial economics. The agency theoretical view is that an agent will not take decisions which attempt to maximize the long-term value of the firm, but rather will take decisions out of self' interest to benefit the agent to the detriment of the principal.
The view of man taken by agency theory, by contrast to stewardship theory, is that people cannot be trusted to act in the public good in general and in the interests of the shareholders in particular: they need to be monitored and controlled to ensure compliance. Such check and balance mechanisms, obviously, incur agency costs. Jensen and Meckling argue that firms should incur such agency costs of enforcement to the point at which the reduction of the loss from non-compliance equals the increase in enforcement costs.
Examples of such agency costs being incurred in practice include board structures which emphasize outside, independent directors, committees of the board comprising independent directors to be concerned with audit, top management remuneration and the nomination of new directors, and the separation of the 1 roles of chairman and chief executive officer.
Elaboration of agency theory applied to governance issues is contained in the readings.
Further theoretical insights relevant to corporate governance on an international dimension may be found in cross-cultural studies. Research in this area has hardly begun, but suffice it here to comment that both stewardship theory and agency theory are Western in context, assuming rational, unemotional, contractual relationships based on the desirability of order with appropriate procedures and rules, with participative and open styles of relationship and ready access to information. Corporate governance in other parts of the world, throughout most of the Pacific Basin for example, must be practiced within different philosophical traditions, where responsibility, ready acceptance of hierarchical control, respect for authority, paternalism, collectivities rather than individual, and secrecy may be the norm.
Task 2. Talking Point 1
Work in groups of three, consult Speaking References p.126–130 and discuss the following:
▪ What qualities/features does deciding on board nominations depend on?
▪ Expand on being “the wise man”, “the specialist”, “the window-on-the-world”.
▪ Expand on being “the contact-person”, “the figure-head role”, “the status-provider”.
▪ Expand on being “a judge”, “the catalyst”, “the monitor or supervisor”, “watchdog role”, “confidant”, “the safety-valve”.
▪ How much do the basic companies ordinances differ in different countries? Take into consideration: laws rooted in Roman law/within the case-oriented legal structures.
▪ What is the underlying basis of power to nominate and elect directors?
▪ Who does hold the confirming power?
▪ What are the basic responsibilities of the shareholders?
▪ Expand on acting honestly in good faith
▪ What are the main duties imposed on directors?
▪ What is the nature of man in accordance with the original corporate concept?
▪ Expand on stewardship theory/Criticism on “stewardship theory
▪ Expand on the agency theory.
Task 3. Reading 2
Getting started
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