CORPORATE GOVERNANCE

Corporate Governance

Corporate Governance

Introduction

The social sciences offer a diverse and sometimes puzzling array of definitions for corporate governance. According to one extreme view, the term refers to the ways in which the shareholders of the firm seek to assure themselves an adequate return on their investment. This definition is consistent with the branch of economics called agency theory, in which shareholders are considered the principals of the firm, managers are their agents, and the overriding dilemma deals with monitoring managers and aligning their interests with those of shareholders in order to maximize the market value of the firm. While critics argue that this definition is too narrow, some organizational theorists such as Gerald Davis and Neil Fligstein point out how this economics-oriented perspective has long dominated United States popular discourse and public policy decisions.

According to a broader definition generally preferred by sociologists and political scientists, corporate governance involves the processes and relationships that affect how corporations are administered and controlled. Advocates of this definition generally agree that the rights, obligations, and relationships relevant to corporate control extend well beyond the so-called tripod of corporate governance, namely, shareholders, managers, and boards of directors. For instance, Carl Kester (1996) defines corporate governance as the “set of incentives, safeguards, and dispute-resolution processes used to order the activities of various corporate stakeholders” such as owners, managers, workers, creditors, suppliers, customers, and the surrounding community.

Conceptual Overview

While the economic and sociological views disagree about which organizational constituents are most critical, both perspectives agree that the resolution of conflicts between key actors is an important element of corporate governance. Both perspectives also concur that corporate governance plays a key role in every economy. A well-functioning corporate governance system can contribute to national wealth, economic efficiency, and perhaps even social equity. A poorly conceived system can wreak havoc on the economy by misallocating resources or failing to check opportunistic behaviors. (Cavers, 1953)

Part of the confusion surrounding the concept of corporate governance can be attributed to the relative newness of the term. Although some sources attribute its origin to the 1970s or 1980s, the first reference in the JSTOR (Journal Storage) archive occurs in 1953, when legal scholar David Cavers used the phrase “corporate governance” as an analog to the lines of communication and authority present in local, state, and national governments. The first appearance of corporate governance in a New York Times article appears to have been in 1978, where it is described as a “fancy term for the various influences that determine what a corporation does and does not do, or should or should not do.”

Despite the youthfulness of the concept, concerns about corporate governance issues are long-lived. The corporate governance historian and researcher Paul Frentrop traces the conflicts of interest among shareholders, managers, and directors to the first joint-stock company, the Dutch East India Company, in 1602. In his Wealth of Nations, Adam Smith described the incentive difficulties inherent in hiring professional directors to act as stewards of “other people's ...