The document discusses various theories of corporate governance including agency theory, stewardship theory, stakeholder theory, resource dependency theory, transaction cost theory, and political theory. It also discusses key aspects of the new Indian Companies Act 2013 which aims to strengthen corporate governance standards in India through provisions related to boards of directors, independent directors, class action suits, auditor rotation, and fraud investigation. The new law is an important step for corporate governance in India but will require proactive implementation and clarification from regulators.

1. Unit-6

2.  Corporate governance is the system of rules,
practices, and processes by which a firm is
directed and controlled. Corporate governance
essentially involves balancing the interests of a
company's many stakeholders, such as
shareholders, senior management executives,
customers, suppliers, financiers, the government,
and the community. Since corporate governance
also provides the framework for attaining a
company's objectives, it encompasses practically
every sphere of management, from action plans
and internal controls to performance
measurement and corporate disclosure.

3. Governance refers specifically to the set of rules, controls,
policies, and resolutions put in place to dictate corporate
behavior. Proxy (representative )advisors and shareholders
are important stakeholders who indirectly affect
governance, but these are not examples of governance
itself. The board of directors is pivotal in governance, and
it can have major ramifications for equity valuation.
Communicating a firm's corporate governance is a key
component of community and investor relations. On Apple
Inc.'s investor relations site, for example, the firm outlines
its corporate leadership—its executive team, its board of
directors—and its corporate governance, including its
committee charters and governance documents, such as
bylaws, stock ownership guidelines and articles of
incorporation.

4.  Most companies strive to have a high level of
corporate governance. For many
shareholders, it is not enough for a company
to merely be profitable; it also needs to
demonstrate good corporate
citizenship through environmental awareness,
ethical behavior, and sound corporate
governance practices. Good corporate
governance creates a transparent set of rules
and controls in which shareholders, directors,
and officers have aligned incentives.

5.  Corporate governance is the structure of
rules, practices, and processes used to direct
and manage a company.
 A company's board of directors is the primary
force influencing corporate governance.
 Bad corporate governance can cast doubt on
a company's reliability, integrity, and
transparency—all of which can have
implications on its financial health.

6.  Good corporate governance ensures corporate success and
economic growth.
 Strong corporate governance maintains investors’
confidence, as a result of which, company can raise capital
efficiently and effectively.
 It lowers the capital cost.
 There is a positive impact on the share price.
 It provides proper inducement to the owners as well as
managers to achieve objectives that are in interests of the
shareholders and the organization.
 Good corporate governance also minimizes wastages,
corruption, risks and mismanagement.
 It helps in brand formation and development.
 It ensures organization in managed in a manner that fits
the best interests of all.

7. The board of directors is the primary direct stakeholder
influencing corporate governance. Directors are elected by
shareholders or appointed by other board members, and they
represent shareholders of the company. The board is tasked with
making important decisions, such as corporate officer
appointments, executive compensation, and dividend policy. In
some instances, board obligations stretch beyond financial
optimization, as when shareholder resolutions call for certain
social or environmental concerns to be prioritized.
Boards are often made up of inside and independent members.
Insiders are major shareholders, founders and executives.
Independent directors do not share the ties of the insiders, but
they are chosen because of their experience managing or
directing other large companies. Independents are considered
helpful for governance because they dilute the concentration of
power and help align shareholder interest with those of the
insiders.

8. Bad corporate governance can cast doubt on a
company's reliability, integrity or obligation to
shareholders—all of which can have implications on
the firm's financial health. Tolerance or support of
illegal activities can create scandals like the one that
rocked Volkswagen AG starting in September 2015.
The development of the details of "Dieselgate" (as the
affair came to be known) revealed that for years, the
automaker had deliberately and systematically rigged
engine emission equipment in its cars in order to
manipulate pollution test results, in America and
Europe. Volkswagen saw its stock shed nearly half its
value in the days following the start of the scandal,
and its global sales in the first full month following
the news fell 4.5%.

9. :
 Companies do not cooperate sufficiently with
auditors or do not select auditors with the
appropriate scale, resulting in the publication of
spurious or noncompliant financial documents.
 Bad executive compensation packages fail to
create an optimal incentive for corporate officers.
 Poorly structured boards make it too difficult for
shareholders to oust ineffective incumbents.

10. There are many theories of corporate
governance which addressed the challenges
of governance of firms and companies from
time to time. The Corporate Governance is
the process of decision making and the
process by which decisions are implemented
in large businesses is known as Corporate
Governance. There are various theories which
describe the relationship between various
stakeholders of the business while carrying
out the activity of the business.

11.  Agency Theory
 Stewardship Theory
 Resource Dependency Theory
 Stakeholder Theory
 Transaction Cost Theory
 Political Theory

12.  Agency theory defines the relationship between the
principals (such as shareholders of company) and agents
(such as directors of company). According to this theory,
the principals of the company hire the agents to perform
work. The principals delegate the work of running the
business to the directors or managers, who are agents of
shareholders. The shareholders expect the agents to act
and make decisions in the best interest of principal. On
the contrary, it is not necessary that agent make decisions
in the best interests of the principals. The agent may be
succumbed to self-interest, opportunistic behavior and fall
short of expectations of the principal. The key feature of
agency theory is separation of ownership and control. The
theory prescribes that people or employees are held
accountable in their tasks and responsibilities. Rewards
and Punishments can be used to correct the priorities of
agents.

14. The steward theory states that a steward protects
and maximizes shareholders wealth through firm
Performance. Stewards are company executives
and managers working for the shareholders,
protects and make profits for the shareholders.
The stewards are satisfied and motivated when
organizational success is attained. It stresses on
the position of employees or executives to act
more autonomously so that the shareholders’
returns are maximized. The employees take
ownership of their jobs and work at them
diligently.

15.  Stakeholder theory incorporated the
accountability of management to a broad
range of stakeholders. It states that managers
in organizations have a network of
relationships to serve – this includes the
suppliers, employees and business partners.
The theory focuses on managerial decision
making and interests of all stakeholders have
intrinsic value, and no sets of interests is
assumed to dominate the others

17.  The Resource Dependency Theory focuses on the role
of board directors in providing access to resources
needed by the firm. It states that directors play an
important role in providing or securing essential
resources to an organization through their linkages
to the external environment. The provision of
resources enhances organizational functioning, firm’s
performance and its survival. The directors bring
resources to the firm, such as information, skills,
access to key constituents such as suppliers, buyers,
public policy makers, social groups as well as
legitimacy. Directors can be classified into four
categories of insiders, business experts, support
specialists and community influentials.

18.  Political theory brings the approach of
developing voting support from shareholders,
rather by purchasing voting power. It
highlights the allocation of corporate power,
profits and privileges are determined via the
governments’ favor

19.  Transaction cost theory can be viewed as part of corporate
governance and agency theory. It is based on the principle that
costs will arise when you get someone else to do something for
you .e.g. directors to run the business you own.
 Transaction cost theory (Wiliamson) was first discussed in the
context of the decision by a firm whether to do something in-
house or to outsource.
 Organisations choose between two methods of obtaining control
over resources:
 the ownership of assets (hierarchy solutions – decisions over
production, supply, and the purchases of inputs are made by
managers and imposed through hierarchies) and
 buying in the use of assets (the market solution – individuals and
firms make independent decisions that are guided and
coordinated by market prices).

20. The decision is based on a comparison of the
"transaction costs" of the two approaches.
Transaction costs are the indirect costs (i.e. non
production costs) incurred in performing a
particular activity, for example the expenses
incurred through outsourcing.
When outsourcing, transaction costs arise from
the effort that must be put into specifying what is
required and subsequently coordinating delivery
and monitoring quality.
High transaction costs for outsourcing may
suggest an in-house solution whereas low
transaction costs for outsourcing would support
the argument to outsource.

21.  Governance
 Transaction cost theory can be applied to a
discussion of governance by viewing it as as
an alternative variant of the agency
understanding of governance assumptions. It
describes governance frameworks as being
based on the net effects of internal and
external transactions, rather than as
contractual relationships outside the firm (i.e.
with shareholders).

22.  Transaction costs will occur when dealing with another
external party:
 Search and information costs: to find the supplier.
 Bargaining and decision costs: to purchase the
component.
 Policing and enforcement costs: to monitor quality.
 The way in which a company is organised can determine
its control over transactions, and hence costs. It is in the
interests of management to internalise transactions as
much as possible, to remove these costs and the
resulting risks and uncertainties about prices and quality.
 For example a beer company owning breweries, public
houses and suppliers removes the problems of negotiating
prices between supplier and retailer.

23. Transaction costs can be further impacted by the following:
 Bounded rationality: our limited capacity to understand business
situations, which limits the factors we consider in the decision.
 Opportunism: actions taken in an individual's best interests,
which can create uncertainty in dealings and mistrust between
parties.
The significance and impact of these criteria will allow the
company to decide whether to expand internally (possibly
through vertical integration) or deal with external parties.
The variables that dictate the impact on the transaction costs are:
 Frequency: how often such a transaction is made.
 Uncertainty: long term relationships are more uncertain, close
relationships are more uncertain, lack of trust leads to
uncertainty.
 Asset specificity: how unique the component is for your needs.

24. Transaction costs still occur within a company, transacting
between departments or business units. The same
concepts of bounded rationality and opportunism on the
part of directors or managers can be used to view the
motivation behind any decision.
The three variables given above can be applied to all
behavior by managers:
 Asset specificity: amount the manager will personally gain.
 Certainty: or otherwise of being caught.
 Frequency: endemic nature of such action within corporate
culture
 The degree of impact of the three variables leads to a
precise determination of the degree of monitoring and
control needed by senior management.

25. Possible conclusions from transaction cost theory
 Opportunistic behaviour could have dire consequences on financing and strategy
of businesses, hence discouraging potential investors. Businesses therefore
organise themselves to minimise the impact of bounded rationality and
opportunism as much as possible.
 Governance costs build up including internal controls to monitor management.
 Managers become more risk averse seeking the safe ground of easily governed
markets.
Transaction cost theory versus agency theory
Transaction cost theory and agency theory essentially deal with the same issues
and problems. Where agency theory focuses on the individual agent, transaction
cost theory focuses on the individual transaction.
 Agency theory looks at the tendency of directors to act in their own best interests,
pursuing salary and status. Transaction cost theory considers that managers (or
directors) may arrange transactions in an opportunistic way.
 The corporate governance problem of transaction cost theory is, however, not the
protection of ownership rights of shareholders (as is the agency theory focus),
rather the effective and efficient accomplishment of transactions by firms.

26.  legislation is imperative.
 As corporations increasingly access global pools of financial and human capital, partner with
vendors on mega collaborations, and are required to function in harmony with the community,
corporate governance becomes imperative.
 India is close to having one million registered companies, and the need for a strong company
legislation is even greater. The new Companies Act intends to bring governance standards on
par with those in developed nations through several key provisions, such as composition and
function of Board of directors, code for independent directors, performance evaluation of
independent directors, class action suits, auditor rotation and independence, and
establishment of Serious Fraud Investigation Office.
 Board of directors
 The Act recognises the Board as a key component and entrusts it with significant
responsibilities for strong internal controls and risk management.
 Besides the audit committee, listed and prescribed class of companies should constitute the
nomination and remuneration committee and stakeholder relationship committee. The Act
stipulates appointing at least one woman director in listed and prescribed class of companies.
 Independent directors
 The concept of independent directors has been introduced for the first time in the Companies
Act.
 The Act lays down the qualification, code of professional conduct (includes assisting
companies in implementing best corporate governance practices), performance evaluation
mechanism, and duties of independent directors. Independent directors will now have greater
responsibility to ensure a vigilant and active board.
 While this is a welcome step, there may be an element of subjectivity when enforcing
compliance.

27.  Class action suits
 The concept of class action suits is prevalent in countries like the US and the UK. The
Companies Act now allows a requisite number of members or depositors or any class of them
to file an application before the National Company Law Tribunal (NCLT), if they feel that the
company’s affairs are being conducted in a manner prejudicial to the interests of the company,
its members or depositors.
 The average value of a settlement in the US in the first half of 2012 was $71 million — a sharp
rise from $46 million during 2005–2011. Major allegations in the suits included operational
shortcomings/ product defects (45 per cent), followed by accounting, breach of fiduciary duty,
and customer/ vendor issues.
 Audit and auditors
 Auditor rotation has been made mandatory for listed and prescribed class of companies. Severe
penal provisions have been introduced to enforce compliance. Most countries do not have
mandatory rotation of audit firms, even as they mandate the rotation of audit partners.
Regulators in the UK, the US, and Germany have discussed the topic in the past, but concluded
that the potential benefits of mandatory rotation do not outweigh the risks and costs.
 Fraud Investigation
 The Government shall establish a Serious Fraud Investigation Office (SFIO) for companies, and
stringent penal provisions have been defined for fraud-related offences.
 In summary, the Act is a landmark development in the Indian corporate landscape. The impact
of the new pronouncement should not be underestimated, and companies and other
stakeholders should start evaluating the implications and act swiftly.
 The Ministry of Corporate Affairs will have to proactively issue circulars and clarifications to
ensure the act is implemented in the right spirit.