Agency Theory and Stewardship Theory
There is no singular framework theory for corporate governance. The understanding of a number of theories provides the opportunity to consider governance issues. This in turn allows us to consider why we even need governance [1]
The Agency Problem
The agency problem is a constant in corporate governance as in other areas also. The problem arises when someone delegates the authority to manage an asset on their behalf as an agent. A conflict of interest can easily arise where the agent is torn between acting in their own interest or doing what they are supposed to be doing which is acting in the best interests of the principal. The Agency Problem is also referred to as the Agency Dilemma.
In the area of corporate governance, the agency problem is most notable where a conflict of interest arises between the organisation’s shareholders (principals) and the directors of the organisation (agents).
Humans have always been subjected to temptation and the management of other people’s assets is no different. There will always be the temptation to act in one’s own interest instead of discharging your duties appropriately. Of course, this not only happens on company boards where directors need to act in the best interest of shareholders, it can also occur in non-profits.
A non-profit board director may be charged with acting in the interest of a community, aged care residents, or perhaps a group of farmers in a cooperative. The same problem arises yet again.
Through good governance practices of having independent boards and clear policies on conflict of interest, the agency problem can be minimised.
Agency Theory
Agency arises because some people are more qualified or knowledgeable about particular matters than others. Directors know more than the vast majority of shareholders about compliance and business. Likewise, sharebrokers have a greater knowledge of share performance and measurements than many shareholders. Such situations create the perfect storm where the agents can take advantage of the lack of knowledge of the principals for whom they act.
The image shows the contractual relationship between the shareholders who are the principals and the directors who are the agents.
It is unfortunate, but there are many examples of where directors have failed in their duty of care to shareholders. They have taken advantage of their position and power to cream large amounts of money off the company where they are directors.
Agency theory does have its critics however who suggest that it is too simplistic. They argue that agency theory goes to the nature of mankind and that loading up governance with additional layers of compliance can detract from governance rather than add to it (Tricker, 2019)
Stewardship Theory
One of the problems with Agency Theory is that it assumes that no one can be trusted and they will always act out of self-interest. Not only is this not true, but it could be considered an affront to many directors who act with integrity and honesty in all their dealings.
Stewardship Theory takes the position that directors do not always act out of self-interest. In fact, they act with all due integrity and the independence appropriate to fulfil their duties to the law, society and the shareholders.
Resource Dependency Theory
Resource dependency theory effectively places the board in the middle of a relationship between the company and the outside world. Such links would be to customers, suppliers, lenders etc. This theory considers directors almost as intermediaries that can provide access to the company’s needs through their connections.
Social Network Theory
Social network theory also looks at the connections between people. Wherever relationships exist by whatever means socially, there is potential for them to be used by directors.
Stakeholder Theory
Stakeholder theory maintains that as companies gain in power and influence that the directors have an increased level of responsibility. In addition to shareholders, this responsibility extends to all stakeholders including the community at large, the environment and anybody or anything where their decisions may have an impact.
Regulatory Frameworks
Compliance with the law around corporate and organisational behaviour is an essential aspect of governance. A lot of the frameworks and regulations have arisen because of the behaviour of organisations. It should be remembered that compliance does not necessarily mean good governance, it simply means that the organisation has complied with the framework. Governance is much more than compliance.
Regulation Types
Four types of regulation exist that apply to corporate governance. These are:-
- Company law (or organisational law for the specific type)
- Accounting standards
- Stock exchange listing rules
- Discretionary corporate governance codes
Laws affecting companies and other types of organisations vary across jurisdictions. However, in their most basic form, they will lay out the procedure for incorporation, director appointments and documentation requirements in terms of filing.
Conversely, governance codes are discretionary. Despite being discretionary, companies are required to confirm whether or not they have complied with the code. If there have been departures, they must be explained.
Rule Based vs Principle Based
In the US, governance is very much rules-based. But in the EU, Commonwealth countries and elsewhere in the world, there is more of a philosophy of self-regulation. There is still the corporations’ law, but more of an emphasis on principle-based regulation. This is the case in Australia where companies follow the code and report when they do not.
Corporate Governance Codes
There are several corporate governance codes around the world to draw from. The OECD published their latest set of principles at the G20 meeting in 2015. These can be downloaded in PDF form from the OECD website. OECD Corporate Governance Principles
In Australia, the Australian Securities Exchange provides the Governance Principles which can be obtained from their website. ASX Corporate Governance Principles
There is also some excellent reading on the Australian Charities and Not For Profit Commission (ACNC), but unfortunately, they are not downloadable. Governance for good: The ACNC’s guide for charity board members | ACNC. The Australian Institute of Company Directors also has a code for not-for-profits which can be downloaded from the Wayback Machine. This link is to the Internet Archive and should continue to be available.
Summary
This module covered a number of theories and frameworks around corporate governance. Agency theory implies people can’t be trusted to discharge their responsibilities and always act in the interest of the principals. Conversely, Stewardship theory contends that people don’t always act to maximise the benefit to themselves. The module also covered the relationships that can be generated by directors as a result of Resource Dependency and Social Network theories. Finally, the module considers regulatory frameworks and compliance requirements and provided links to some valuable governance codes included above.
References- Module 2: Key theories and regulatory frameworks: Agency theory and stewardship theory 2022, Aib.edu.au, viewed 28 October 2022, <https://learning.aib.edu.au/mod/book/view.php?id=116283>[↩]
- Tricker, B 2019, Corporate governance: Principles, policies and practice, 4th edn, Oxford University Press, London.[↩]
