1

A Literature Review of Corporate

Governance
(5009)

Submitted by

MSc. Administrative Sciences

Semester: Spring, 2020

______________________________________________________________________

DEPARTMENT OF BUSINESS ADMINISTRATION

ALLAMA IQBAL OPEN UNIVERSITY ISLAMABAD

 2

Introduction

Corporate governance is the broad term desribes the processes, customs, policies, laws and

institutions that directs the organizations and corporations in the way they act, administer and

controll their operations.It works to achieve the goal of the organization and manages the

relationship among the stakeholders including the board of directors and the shareholders.It

also deals with the accountability of the individuals through a mechanism which reduces the

principal-agent problem in the organization. Fine corporate governance is an essential

standard for establishing the striking investment environment which is needed by competitive

companies to gain strong position in efficient financial markets. Good corporate governance

is fundamental to the economies with extensive business background and also facilitates the

success for entrepreneurship. During the last two decades the research area in finance is

primarily focus on the area of corporate governance. The separation of ownership from

control is the core of the agency problems facing by the firms (Berle & Means 1932; Jensen

& Meckling 1976). This leads to many issues related to efficient control for the assets of

corporations in the interest of all company’s stakeholders. A great research has been done in

the area of corporate governance by keeping the agency related problem. Core (1999) firms

who have weaker governance to direct and manage company matter face greater agency

problems. The agency problem allows manager to extract more private benefits and the firm

ultimately performs worse. Firms therefore, needed for the improved corporate governance in

order to survive for long term growth and survival. A good corporate governance can occur in

the organization by putting the balance between the ownership and control and also among

the interests of stakeholders of the firm. This approach might be helpful in developing the

positive attitude among the manager and shareholders and reduces the agency problems in the

firms.This paper presents the broad view of corporate governance from various perspectives

and tries to link it with the agency problems where required. It gives an overview that how
 3

corporate governance handles the deviation between the mangers and shareholders interests.

The mechanism of effective corporate governance will help to determine the difference

between ownership and control by giving the view of topic from different angles and tries to

solve the agency problems in the organizations.

Literature Review of Corporate Governance

Corporate governance importance arises in modern corporations due to the separation of

management and ownership control in the organizations. The interests of shareholders are

conflicting with the interests of managers. The principal agent problem is reflected in the

management and direction related problems due to the differential interests of firm’s

stakeholders. There is not a single definition of corporate governance rather it might be

viewed from different angles. Berle and Means (1932) and the even earlier Smith (1776).

Zingales (1998) defines corporate governance as “allocation of ownership, capital structure,

managerial incentive schemes, takeovers, board of directors, pressure from institutional

investors, product market competition, labour market competition, organisational structure,

etc., can all be thought of as institutions that affect the process through which quasi-rents are

distributed (p. 4)”. Garvey and Swan (1994) assert that “governance determines how the

firm’s top decision makers (executives) actually administer such contracts (p. 139)”. Shleifer

and Vishny (1997) define corporate governance as “the ways in which suppliers of finance to

corporations assure themselves of getting a return on their investment (p.737)”. OECD in

1999 defined corporate governance as "Corporate governance is the system by which

business corporations are directed and controlled. The corporate governance structure

specifies the distribution of rights and responsibilities among different participants in the

corporation, such as, the board, managers, shareholders and other stakeholders, and spells out

the rules and procedures for making decisions on corporate affairs. By doing this, it also

provides the structure through which the company objectives are set, and the means of
 4

attaining those objectives and monitoring performance.” Oman (2001) defined corporate

governance as a term refers to the private and public institutions that include laws,

regulations and the business practices which governs the relationship between the corporate

managers and the stakeholders.The Ministry of Finance, Singapore (CORPORATE

GOVERNANCEC 2001) defines corporate governance as “the processes and structure by

which the business and affairs of the company are directed and managed, in order to enhance

long term shareholder value through enhancing corporate performance and accountability,

whilst taking into account the interests of other stakeholders. Good corporate governance

therefore embodies both enterprise (performance) and accountability (conformance).” (Fin,

2004, pp 13-14). La Porta, Silanes and Shliefer (2000, 2002) view corporate governance as a

set of mechanisms through which outside investors (shareholders) protect themselves from

inside investors (managers). The Organization for Economic Cooperation and Development

provides another perspective by stating that “corporate governance is the system by which

business corporations are directed and controlled. The corporate governance structure

specifies the distribution of rights and responsibilities among different participants inthe

corporation, such as the Board, managers, shareholders and other stakeholders, and spells out

the rules and procedure for making decisions on corporate affairs. By doing this, it also

provides the structures through which the company objectives are set, and the means of

attaining those objectives and monitoring performance.

A View from Literature of Corporate Governance & Agency Theory

McColgan (2001) gave a very broader view of agency theory and corporate governance. The

major interest of his research was to cover the area that where the interests of managers

diverge from those of the interests of shareholders. He kept in view the agency relationship

and the agency cost which arises from these relationships. He extended the work of Jensen

and Meckling (1976) who defined the agency relationship as a type of contract in which the
 5

principal keep the agent to carry out the services of the firm on his behalf. The agency

problem arises due to the different interest and the conflict between the ownership and

control as principal delegate some decision making authority to the agent. Jensen and

Meckling (1976) argued that this delegation authority reduces the value maximizing

decisions taking by the manager in the firm. Himmelberg,, Hubbard and Palia. (1999), argued

Jenson and Meckling (1976) by saying that principal agent problem are not similar in all

firms rather they are different in different firms, different industries and also in different

cultures. Himmelberg et al. (1999) said that Jenson original theory “nexus of contract’

suggest the same. McColgan (2001) agreeing with the authors said that agency problem can

be reduces by the help of effective corporate governance mechanism which can be important

in reducing the agency cost and the ownership problems in the firms. The governance should

be design according to the firm environment as one general mechanism can be more

important for some firms and less important for other firms. Okeahalam and Akinboade

(2003) reviewed the issues and challenges of corporate governance in Africa. They presented

the reason for their review that many of the non financial corporations failed in the United

States and in Asia due to the non efficient corporate governance. They said that Africa can

learn a great from the experiences of these countries and may improve the governance for its

corporate sector. Okeahalam and Akinboade (2003) conducted the review by studying a

contribution on the corporate governance in Africa and said that the modern concepts of

separation of management from the ownership make the corporate governance an important

issue for research. The interests of people who control the organizations are differing from

those who invest in the company by external finance. Also the principal agent problem and

the interest of shareholders can only reduced through the effective corporate governance.

Okeahalam and Akinboade (2003) stated that the organization systems, practices, process and

rules of governing institutions are concerned closely with the corporate governance so there
 6

is a need to find those relationships that regulate, create or determine the nature of

relationship through those relationships. Corporate governance implies that companies should

balance between the interests of shareholders with stakeholders at all levels of organization.

Okeahalam and Akinboade (2003) stated that Africa is highly influence by mismanagement,

corruption in business environment, therefore effective corporate governance can create the

transparency and safeguard against these threats facing by the companies to promote the

foreign investment by foreign traders and companies. The authors stated that research

publication in the area of corporate governance is very low and suggested that the research

should be promoted in both empirical and theoretical ways. Farinha (2003) conducted the

theoretical and empirical literature review to find out the true nature and consequences of

corporate governance. The main focus of his literature was to find out the reasons of conflict

between manager and shareholders in organizations with respect to ownership mechanism.

He also tried to find out the link between the corporate governance and the value of the firm.

Farinha (2003) argued that major problem in organization arises with the relationship of

principal and agent relationships and a different approach of manager than the shareholders.

The perspective of the manager remains with the limited cash-flows thus managers focus lies

with the short term perspective on investment whereas shareholders stuck with the quick

return of cash flows. Risk preference is also a major source of conflict between the principal

and the agent. Shareholders associated with the market risk and the risk of stock returns

whereas managers always concerned with the company risk because their survival depends

on the firm risk. The area of corporate governance is lacking with the external disciplining

devices. The firms through the effective corporate governance can implement these devices

which includes the composition of the board of directors, increase number of shareholders,

maximize the inside ownership and by providing different financial policies and

compensation packages. Filatotchev, Lien and Piesse (2004) studied the Corporate
 7

Governance and Performance in Publicly Listed, Family-controlled Firms in Taiwan. They

analyzed the effects of the structure of ownership and board characteristics on performance in

large, publicly traded firms which are controlled by family controlled firms. The authors

argued that firms located in East Asia, operate with a distinctive culture and in different legal

and institutional environments than west and Europe, These culture differences may have a

strong impact on governance-performance relationships suggested by the study of agency and

strategy research. The authors did not find a direct association between family ownership and

managerial entrenchment and extraction of the private benefits of this control, which might

be the negative cause to financial performance. The authors also identified the differences in

corporate governance effects which are associated with different types of institutional

shareholders. Filatotchev, Lien and Piesse (2004) suggested that foreign investors may attract

to the Taiwan markets by the process of globalization which may lead to good corporate

governance being imported by the domestic firms in Taiwan. The results of their study also

find that family control over the executive board is the major determinant to the performance.

Becher and Campbell (2004) studied the corporate governance of bank mergers and

acquisitions. He was of a view that during these mergers and acquisitions the CEOs

negotiates for their own interests whereas the outside directors of the company face the

financial problems. The corporate governance of independent companies affected a

lot.Becher and Campbell (2004) made empirical investigation to find out the effects of

personal benefits and the merger premiums by taking a sample of 146 mergers of large US

banks in 1990s. They targeted the two thousand directors and executives during these

mergers and found that target’s merger premium is inversely related to the number of target

directors who are retained during these mergers. This also implies for the corporation size,

incentives, payment methods and bidder returns. The study found that the interests of target

director relatively lies with the size of the company rather than performance and they exercise
 8

their bargaining power with the acquirer which counters the interests of shareholders interest

in the merger. Novikova (2004) studied the impact of internal corporate governance system

on firms innovative activities and addressed the question that how much firms internal

corporate governance system varieties with the type and efficiency of firm’s innovative

activities. Novikova (2004) listed out major participative actors for the firms which are the

board, the shareholders, the managers and the other stakeholders for the companies. He

defined the institutions as the rules and procedures use to make decisions on corporate affairs

of the firm. Novikova (2004) designed his research on the definition of OECD which defines

corporate governance in a narrow term as a relationship between a company and its

shareholder whereas in broader term the relationship between the company and the society.

Kowalewski, Stetsyuk and Talavera (2007) studied the corporate governance practices in

determining the dividend policy in Poland. Jensen (1986) said that dividends can reduce the

agency costs because of the distribution of free cash flows that can be spent on the

unprofitable projects by the firm’s management. Gompers, Ishii, and Metrick (2003) in their

research on agency cost also said that agency cost is the strengthen relationship between the

shareholders rights and its associated with the corporate governance. Kowalewski et al.

(2007) studied the view of many authors in their extensive literature on the topic and found

that by empirical implications that corporate governance is an important determinant for

explaining the dividend policies. They also found that larger asset retain companies and

highly profitable firms without good investment opportunities pay more dividends whereas

the high risks and indebt firms pay low dividends. In Poland the companies with strong

corporate governance practices and strong shareholder rights pays higher dividends and it

mitigates the agency problems in the Poland. Another study conducted by Cueto (2007) to

find out the role of ownership mechanism and corporate governance practices in emerging

markets of Latin America. In context of weak shareholder protections the corporate

 9

governance mechanism affects the firm value, the liquidity of market and the organization of

industries. Cueto (2007) proposed that the relationship between the corporate governance

mechanism and the firm’s value and the effects of ownership structure and among the

liquidity of the stock market must be explored.

Conclusion

In this review which is a collection of volume of research on corporate governance the

significance of effective corporate governance is being evident. The aim of the review done is

to check the effectiveness of corporate governance and its effective mechanism in running

and managing the business operations. The issue of ownership and control and the principal-

agent problem and its effect on corporate governance is the main area of research in this

review. The findings of the most studies show that effective corporate governance reduces the

ownership and control problems and draws a clear line between the shareholder and the

manager. Finally from the discussion from all articles this review provides a general

overview of principal-agent problem and ownership and control for the researchers and

academic practitioners in the domain of corporate governance.

Limitations of the Study

There are many limitations in the review conducted in this paper which can be associated

with the lack of time. Due to shorter period of time the study is conducted only by focusing

on studies taking from the perspective of different countries. Each country is located in

separate region and the cultural aspect of different nations can influence the practices of the

business and its corporate governance. Due to the shortage of time the empirical aspect of

study never being came into focus. More attention should be focus on the practical aspect of

the corporate governance and its practices in real business environment need to be study

closely.

References
 10

[1] Berle, A. A. and Means, G. C. (1932), “The Modern Corporation and Private

Property”,Macmillan, NY.

[2] Becher. D. A., and Campbell. T.L (2004), “Corporate governance of bank mergers”.Core,

J. E., Holthausen, R. W. and Larcker, D. F. (1999), “Corporate governance, chief executive

officer compensation, and firm performance”, Journal of Financial Economics, vol. 51, no. 3,

pp. 371-406.

[3] Farinha. J (2003), “Corporate Governance: A Survey of The Literature”, JEL

Classification: G300. Gompers P., J. L. Ishii, and A. Metrick (2003), "Corporate governance

and equity prices",Quarterly Journal of Economics 118: 107-155.

[4] Himmelberg, C.P., R.G. Hubbard and D. Palia. (1999), “Understanding the determinants

of Ownership and the link between Ownership and Performance”, Journal of Financial

Economics 53, 353-384.

[5] Jensen, M.C. and W.H. Meckling. (1976), “Theory of the Firm: Managerial Behaviour,

Agency Costs and Ownership Structure”, Journal of Financial Economics 3 (4), 305-360.

[6] Jensen M. (1986), “Agency costs of free cash flow, corporate finance, and takeovers”,

American Economic Review 76: 323-329.

[7] Kole, S. (1995), “Measuring Managerial Equity Ownership: a comparison of sources of

Ownership data” , Journal of Corporate Finance 1, 413-435.

[8] Kole, S. (1997), “The Complexity of Compensation Contracts”, Journal of Financial

Economics, Vol. 43, pp. 79-104.

[9] Kowalewski . O, Stetsyuk. I. and Talavera. O (2007), “Corporate Governance and

Dividend Policy in Poland”.

[10] La Porta, R., Lopez-De-Silanes, F. and Shleifer, A. (2000), “Investor protection and

corporate governance”, Journal of Financial Economics, vol. 58, no. 1-2, pp. 3-27.
 11

[11] La Porta, R., Lopez-De-Silanes, F., Shleifer, A. and Vishny, R. W. (2002), “Investor

Protection and Corporate Valuation”, The Journal of Finance, vol. 57, no. 3, pp. 1147-1170.

[12] McColgan P., (2001), “Agency theory and corporate governance: a review of the

literature from a UK perspective”, Department of Accounting & Finance, University of

Strathclyde,Glasgow.

[13] Novikova (2004), “The Impact of Internal Corporate Governance System on Firms

Innovative Activities”, Research design to be presented at the DRUID Academy’s Winter

Conference on Innovation, Growth and Industrial Dynamics Aalborg, Denmark

[14] Okeahalam C., and Akinboade. O. A., (2003), “A Review of Corporate Governance in

Africa:Literature, Issues and Challenges”, Global Corporate Governance Forum.

[15] Oman, C. P. (2001), “Corporate Governance and National Development”, An outgrowth

of the OECD Development Centre s Experts Workshop in 2000 and Informal Policy

Dialogue in 2001 sponsored in part by CIPE.

[16] Piesse. J, Lien. Y, and Filatotchev. I (2004),“Corporate Governance and Performance in

Publicly Listed, Familycontrolled Firms: Evidence from Taiwan” , Department of

Management , King’s college of London.

[17] Pei Sai Fan (2004), “Review Of Literature & Empirical Research on Corporate

Governance”, Financial Services Group Training Unit Monetary Authority Of Singapore.