This article has been written by Deyasini Chakrabarti from KIIT School of law, Bhubaneswar, Odisha. This article mainly focuses on stakeholders’ governance, the objectives, the agency problem which is a common activity in any organization. It also focuses on the role of psychological aspects, the market for corporate control as well as the importance of shareholders’ democracy in a company.

Introduction

Corporate governance is more of an administrative and managerial aspect of the company. It always acts as a foundation to create a corporate culture of transparency, accountability, and disclosure. Compliance plays a very important role in it, hence it is mostly related with more moral and ethical values, legal frameworks, and voluntarily adopted practices as per the needs of the company. Thus it is a mechanism through which the companies are properly directed, guided, and controlled. The basic and the most important task of corporate governance in a country is to bring proper upbringing of the companies and also to make the country economically sound. When we are linking corporate governance and stakeholders, together, we already have stakeholders theory that is being implemented in corporate governance. Corporate governance is more concerned with many stakeholders and the goals for which the corporation is formed. Hence, the concept of corporate governance is being highlighted by the Cadbury Committee. It mainly focuses on the framework where companies are coordinated and controlled, it includes a lot of procedures, outfits, approaches, laws, and establishments influencing the manner in which a corporation is coordinated, regulated or controlled.

Objectives of corporate governance

The whole idea of corporate governance is better functioning of the corporations and the companies for the betterment of society as a whole. Thus, few of the objectives of corporate governance are:

1. A properly structured Board is capable of taking independent and objective decisions and is in place at the helm of affairs. 
2. The Board is balanced in terms of an adequate number of non-executive and independent directors who will take care of the interests and well-being of all the stakeholders. 
3. The adoption of transparency procedures, practices which help in arriving at decisions on the strength of adequate information. 
4. Board has an effective machinery to subserve the concerns of the stakeholders.
5. Through proper corporate governance, the shareholders are kept properly informed of the relevant development which is impacting the country.
6. Proper monitoring and functioning of the management team are also being secured by corporate governance. 

Therefore by the proper corporate governance, the board remains in effective control of the affairs of corporate governance. Thus when the management, accountability, and transparency improves it fulfills the investors’ expectations and confidence in management and corporation, and in return increases the valuation of the corporation. 

Meaning of a stakeholder

Stakeholders, from the term itself we can understand that they are the persons who are the backbone of the company. They include investors, employees, customers, and suppliers as well. Thus they are the risk-takers of such organizations whose basic or primary duty is to provide funding for the smooth functioning of the organization. However, these stakeholders can be further categorized into internal stakeholders as well as external stakeholders. Therefore, these internal stakeholders are those people who derive their interest from the company through a direct relationship, thus they are the people who are directly impacted through the business of the company. On the other hand, the external stakeholders are those people who don’t have a direct relationship with the company, normally they are a group of individuals or organizations that are impacted by the business of the company. Thus, the principal stakeholders of the corporation are the shareholders, management, and the other board of directors. Other stakeholders include the customers, creditors, suppliers, employees, regulators, and also the community at large.

Stakeholder theory

Stakeholder’s theory focuses on the company’s responsibility towards a wider group of stakeholders rather than the shareholders. A stakeholder can be defined as a person or a group which can be directly or indirectly affected by the actions of the business. 

Edward Freeman was the proposer of the stakeholder’s theory, which was recognized as an important element of corporate social responsibility. Corporate social responsibility from the very term it can be understood that it means the responsibilities of the corporations towards society.

Section 135 of the Companies Act 2013 focuses on the fact of Corporate Social Responsibility.

Stakeholder Theory is a conceptual framework of business ethics and organizational management of business ethics or other organizations. It identifies and models the groups which are the stakeholders of the corporation and both describes various methods to satisfy them. The ethical organization, therefore, recognizes its responsibilities towards the stakeholders.

They are not the real owners of the company. Thus these concepts are legally and economically misleading. There had been no mention of such concepts. Though it can be stated that the shareholders enjoy some rights in a company but they cannot be treated as the real owners of the company. As a result of which the directors do not have a statutory duty to increase the wealth of the shareholder, and neglect that of the stakeholders, therefore they are not the agents of the shareholders and are not bound to comply with their instructions as such. Therefore, it is a matter of utmost and necessary duty of the directors as per Section 166 of the Companies Act to promote the interest of the Directors.

Agency problem

What is agency theory? 

Agency theory examines the relationship between the agents and principals in the business. In an agency relationship, two parties exist – the agent and principal, whereby the former acts and takes decisions on behalf of the latter. This mostly focuses on the relationship between the two and the dominant issues that may surface due to their different risk perspectives and business goals. In finance, the most talked-about agency relationship exists between shareholders and executives of a corporation where the top brass is elected to act in the interest of the true owners of the company.

Agency theory plays an important role in corporate governance as well. It focuses particularly on a specific type of agency relationship that exists between the shareholders, directors, and the management of the company. In true sense, the shareholders are the principals or owners of the corporation who provide funding for the smooth functioning or working for the company. 

Situations of utmost importance in which agency conflicts should be resolved or the reasons for agency problem

• Different risk appetite

Corporate Governance is a continuous procedure among the executives and the board at the same time which ensures undertaking esteem. So as to find some kind of harmony among creating and protecting value, the executives and the board consider a general risk profile so as to create desires that are built up by the risk appetite of the organization or the company. Dangers are centered around more when an organization is battling to meet targets or execute the goals, however, they are possibly investigated while encountering times of quickened benefits. Thoughtfully, this is evidence that chance risk appetite is a deliberately long haul and dynamic as opposed to a solitary assurance that once in a while is evaluated. In the wake of executing a risk appetite statement into the corporate culture, and the executives and the top managerial staff have built up a relationship of consistent discussion about existing and possible dangers, that the organization or the company is going to face thus at that point has the control to address significant level dangers in any event, while surpassing financial specialist analysis. The unpredictability in the current serious condition requests such order and needs to fulfil such demands. 

• Super self-centred executives

The circumstance could be actually inverse additionally when the managers have an enthusiasm for demonstrating momentary execution to the proprietors to get their compensation increased. This is progressively predominant and an increasingly hazardous circumstance. More or less, there is an issue of objective harmoniousness between the two parties. The corporate administration strategies, which target adjusting the goals of both the head and specialists, are probably going to determine most office clashes. 

Thus, when the agency theory plays such an important role at the same time, it also arises to many agency problems as well. The agency problem is an inevitable aspect of the working of the companies because it is often considered that the agents may earn a greater amount of their profit from the funds provided by their principals. Therefore, if a balance is not being maintained between the two it can lead to the collapse of the corporate structure of the company.  

However, be that as it may, the Indian financial framework has been portrayed by the unpredictable business structure and defective budgetary economic situations combined with the shortcomings in the legitimate frameworks, which has expanded the office clashes between different partners of the associations. The various corporate outrages and the breakdown of worldwide organizations had spread stun waves over the world and shaken the investor’s trust and certainty. The Government of India embraced and executed different administration codes, which had been derived from the worldwide activities on corporate administration for realizing better corporate administration in the Indian corporate part.

The traditional analysis of a firm behaviour is concerned with the potential principal-agent problems between the managers and the owners, with the latter involving individuals and family shareholders. Thus, there is existing dispersed ownership and pyramidal structure. In India, therefore we have concepts of concentrated ownership as well as family-based business ownership. When we are talking about family-based concentrated companies, it is a common feature for the entire corporate sector prevailing in the entire world. As a result of which it can be typically associated with the pyramidal structure of ownership. Thus in this type of shareholdings, there is a cross-holding of shares with the family-owned business among all the members of the family, which is, therefore, forming a greater part of majority shareholders rather than the minority shareholders.

Potential consequences of the agency problem

• The general principal-agent problem

The family held a pyramidal structure in the company mostly comprises the majority of shareholding in the company. Since agency problems are fundamental and avoidable issues that arise in unattached family firms. For the independent family-owned firms, the agency problem is an organizational issue accentuated in the writing (of disparity of interests between utility-maximization owners and scattered proprietors) is probably going to be diminished or disposed of—the interests of proprietors and directors will be adjusted. In any case, this is probably not going to be the situation with pyramidal structures. There is probably going to be a disparity of interest between the minority shareholders (here the principals) and controlling interest (as their agents), in any zone where there are private advantages of control.

• Tunneling

It is one of the most common areas of the agency problem. It means the transfer of resources between related firms which benefits the individuals or groups with control rights. Tunneling is (frequently) a type of moral danger. Given the disparity among control and income rights, it is ideal for controlling proprietors to (somewhat) confiscate the minority public shareholders—in a pyramid regularly from a lower level to the higher level firm. This can take numerous structures: “worth can be moved between controlled firms through exchange valuing, the arrangement of capital at artificial costs; or on the other hand by means of expanded instalments for intangibles, brand names, and insurance”.

• Interaction with capital markets and dynamic processes- potential positive or negative effects of pyramids.

These pyramidal structures can have both positive and negative effects. Where credit and protection markets are defective, a pyramid can help taking care of financing issues through the firm exchanges, both for venture purposes and to enable in any case proficient firms manage shocks. For example,  India’s Tata group has been an important source of relatively efficient internal investment finance, compensating for highly imperfect credit markets.

In any case, there can likewise be negative impacts on capital allocation: regardless of whether there is increasingly productive capital designation inside a business group, there is a wedge between the interior expenses of capital and that of outcast firms. This wedge is probably going to be expanded when relationship-based lending with banks is notable—and particularly when banks structure some portion of the business groups.

Political economy

A more extensive, and conceivably progressively significant, concerns the job of amassed corporate riches in the forming of approaches and foundations. It is often contended that under “oligarchic capitalism”, embodied by far-reaching corporate control by relatively barely any well off families, the “oligarchs” will have an enthusiasm for campaigning for constrained open financial specialists’ privileges, limitations on the entry, less global rivalry, and a smaller capital market. This, for instance, was a component of the examination of Mexico talked about in a previous case, where the goals of the validity issue were by means of the particular arrangement of property rights to a restricted group of insiders. This tackled the speculation issue, however at the expense of productivity, dynamism, and advancement. It is still observed today in the broad administrative catch and inheritance of a restricted, packed financial framework in Mexico (as in numerous nations).

Psychological reasons behind agency problem

Agency problems arise because of the social thought and social behavior of the surroundings or the environments in which the individuals exist. Thus, it gives rise to the concept of attribution which can be defined as an orderly and systematic process because it helps to find genuine causes behind others’ behaviors and on the basis of these causes we arrive at a certain decision about a particular person. As per Heider’s Naive Psychology, in general, behaviors can be caused by personal forces, such as ability or effort, or by environmental forces. If an action is attributed to personal forces, it will have a different meaning than if it is attributed to environmental forces. Thus, these are the utmost reasons why an agency problem arises. The human brain constantly tries to be accepted by their environment and the circumstances in which they exist, therefore, in order to fulfill the interest of the companies, the needs of the members of the company, as well as in order to fulfill their own needs all the interest comes in common conflicts as a result of which agency problem becomes one of the most prominent problems in every company. Milgram (1974) defines that in human behavior there is an agentic shift that occurs when one individual subordinates her actions to the judgment of another. However, social psychologists see problems when agents exhibit “excessive loyalty” to the principal. Thus agency problems in the corporate world mostly arise when there is an excessive concern for the CEOs or majority shareholders, rather than having minimum responsibility towards the shareholders.

Therefore, Agency problem may occur in two forms:

• A type I agency problem occurs if an individual acts for herself when social welfare would be higher if she acted as an agent. 
• A type II agency problem occurs if an individual acts as an agent when social welfare would be higher if she acted for herself.

Conformity also plays an important psychological role which contributes to agency problems. Conformity is a term used to refer to the situation in which individuals change their beliefs or behaviours so that they become more similar to those of other group members. Conformity pressures can arise in any situation involving other people, thus a company serves as the best place for the same. In a conformity situation, the agents have at least some interest in changing the individual’s behaviour. Indeed, in these situations, if the individual’s behavior doesn’t change, it is termed as a defiant. Thus the reason for the agency problem clearly shows that no one would like to portray themselves as deviant in a corporate body, thus conformity to perceived norms exists. 

Market for corporate control

In simple terms market for corporate control means providing a market where importance is given to the role of equity markets in promoting corporate takeovers. Markets for corporate control are thought to perform significant administration work in advancing a more noteworthy shareholder orientation among corporate administration, the monetary capacity of which is’ most unmistakably sketched out by the agency theory. This theory delivers the inquiry with respect to how investors can guarantee that once they contribute their assets, the executives or management will act to their greatest advantage. A study was conducted by Berle and Means (1932) on the growing separation of ownership and control. They noticed a decrease in shareholder’s command over management as possession stakes became minor and increasingly divided among an enormous number of people. Not many incentives exist for divided proprietors to effectively screen the executives. Along these lines, people differentiate their portfolio and lean toward exit over the voice in light of the poor performance. However, it has always been the trend in which smaller shareholders are informed insufficiently as a result of which they are not being given the opportunity to make qualified decisions. Thus this corporate control undergoes a “ market failure”, that needs to be controlled using ways to reduce agency cost. This may include such as the legal protection to the shareholders.

Henry Manne first described the possible governance function of a market for corporate control. “The lower the stock price, relative to what it could be, the more attractive the takeover becomes to those who believe that they can manage the company more efficiently”. There is a binding connection between share prices and managerial performance and thus it showcases for corporate control is another corporate governance mechanism. As investors reacted to poor administrative execution through the exit, the lower share costs made incentives for outside parties to accumulate control rights, supplant the supervisory group, and rebuild the failing to meet expectations of the company. These outsiders can recover their speculation through a share value premium. Markets for corporate control can be characterized as far as exchanges for authority over a company’s shares or offers and happen through a variety of techniques: open market buys, tender offers, arranged offer trades, or challenge over the control of intermediary rights.

Disciplining mechanism

A well-functioning governance system consists of more than just the boards of directors and external auditors. It incorporates every disciplinary system, for example, lawful, administrative, and showcase is driven that impacts the executives to act in light of a legitimate concern for investors or shareholders. Thus some such instances are labour market failure leads to CEO termination, capital market failure leads to higher cost of capital. Any sort of regulatory environment violation leads to litigation. Similarly, the market for corporate control becomes a working force for the CEOs to perform or risk the sale of the company to new concerns.

Market for corporate control is a substitute for corporate governance

Markets for corporate control is a successful instrument for regulating poor administration. It is a summed up danger of takeover which places the board under greater discipline by systematizing an input component between corporate decision and the securities exchange. It expands the extent of the investor’s voice since investor exit prompts the danger of takeover. It is more grounded in the USA and UK bringing in in excess of 200 takeovers as mergers in a year when contrasted with approx. 50 in Germany and Japan.

Implication of the market for corporate control

There may be a negative effect on the management to take over threats by the form of implementation of costly defensive strategies such as gold parachutes or poison pills or by seeking ways to have legal protection. In simple terms, golden parachutes mean a large payment or other financial compensation guaranteed to company executives if they should be dismissed as a result of merger or takeover, on the other hand, poison pills mean tactics which are being used by the company threatened with ab unwelcomed takeover bid to make itself attractive to the bidder. 

Markets for corporate control are a more compelling disciplinary gadget than either observing by institutional financial specialists or by the governing body. But every time the intensity of the mergers and acquisitions market is not by itself evidence of a powerful disciplinary device at work. It can be promoting empire building or tax minimization. But it does not mean that it should not be accepted. It is indeed difficult to comment that it is a substitute for corporate governance but indeed it is the most effective tool for implementing corporate governance in organizations.

Further, other than business sectors for corporate control, product market competition can likewise be demonstrated as a compelling driver of corporate administration. Firms that will be unfit to embrace corporate administration strategy will be supplanted by contenders. Product market competition can somewhat decrease the degree of inefficient work of the management and its advantage. However, a healthy competition would lead to better development of the companies as a whole. Thus such an environment showcases the real pictures of the companies and in case of inefficiency, they are given the option to be declared as bankrupt.

Two approaches to analyze the effects of markets for corporate control

The two approaches are:

1. To look at the offer costs of the target and securing firms around the declaration date of takeover. 
2. To see post assume control over the execution of combined parties, regardless of whether target firm investors, indeed, procure genuine increases or just reflects moves of riches starting with one monetary specialist then onto the next.

On the off chance that takeovers are a method for settling issues related to wasteful administration, or with other productivity increases then the ex-post execution of the merger gathering ought to be better than the weighted normal of the ex-risk execution of the securing and target firm preceding the takeover. 

To close, it is preferably the danger of takeover of the executives over real takeovers that appears to go about as a successful gadget for improving execution.

Shareholders democracy and proxy advisors
corporate governance through corporate social responsibility

Shareholders’ democracy is the ability of the shareholders to influence a board of directors through the exercise of voting rights associated with the share of ownership. Thus, it is one of the most powerful tools in the hands of the shareholders which gives them the opportunity to vote and exercise their rights as a collective owner of the company. It sometimes acts against the goals or self-interest of the management and the board members.

There are two primary means by which investors can apply command over the organization. In this way, in a company that has a regular capital structure, each ordinary shareholder has the privilege to have a state in the corporate decision making by the excellence of his shareholding. This control system is a few times alluded to as control as ‘voice’. The second type of control depends on available powers of the market forces, where there is a functioning business sector in a company’s shares, its investors every once in a while express their disappointment by selling their shares.

Thus the ‘voice’ part of the corporate control process is the procedure which is essentially a quality of popular government that has been imported in the corporate set up in order to provide the shareholders with some rights and controlling instruments in the company. In the advanced shareholding culture, we find that the equitable control instruments that have been given to the shareholders are really being utilized through intermediaries. Presently this instrument of voice is being suppressed as a result of which it is losing its significance and adequacy.

Interpretation of the word “democracy”

When we hear about the word democracy, the thought which immediately comes to our mind is “ India is a democratic country”. Then when we further analyze this statement, we understand that people of India choose their own representatives as a result of which the country is known as democratic. In a similar way, the shareholder’s democracy also plays a vital role in the proper management and profit of the company as a whole. Some of the vital principles of democracy are as follows:

• Transparency

It is one of the most important components of any economical organization. In a hierarchical structure, every other layer of the mechanism is to be followed and maintained and known to one another. Thus the process of governing should be visible and understandable to the majority of the working populations of the company. If there is no transparency, there won’t be any coordination as a result the entire working organization would have collapsed. Thus transparency is mandatory for the smooth functioning of the organization.

•  Accountability

Accountability means being accountable or answerable to each and everyone in the company, for example, the stakeholders, shareholders, the government or even the environment.

• Participation

Each individual in the organization needs to have a say for his or her own. Thus, it could lead to a better working place that would serve not only to the growth of an individual but also to the growth of the company. Thus, shareholder’ democracy or voting is one of the modes in which each individual’s participation could be assured.

Therefore, like in some other Institutional Framework or arrangement of administration, in the Corporations additionally an arrangement of majority rules system exists which follows similar standards yet with less power. The directors in companies are responsible to the shareholders through the shareholders are required to take an interest in the dynamic procedure so as to make a ‘check and balance’ approach and there ought to be transparency in all the activities of the organization whether they are taken by the company or by the investors. Shareholders Democracy which is a piece of corporate popular government implies that an organization is heavily influenced by its shareholders. In this, each investor has an equivalent chance to choose and comprise a top managerial staff to oversee and direct the undertakings of the organization. They act under as specialists and trustees for the organization in a guardian limit. In that capacity, their important support at the company’s meetings is a matter of utmost importance. 

History of shareholders democracy

These had gradually evolved over time which not just benefited the company but also benefited individuals associated with the company. Thus the stages of evolution are as follows:

• The first trend of shareholder democracy came in the 1990s. It was mostly concerned with the stock ownership consolidation in the hands of the institutional investors, which gave them both financial credibility and incentives to play a more active role in the corporate structure.
• The second wave was dominated by the proxy advisors. They provided research and recommendations on how the institutional investors could vote their shares in publicly held companies.
• The third pattern was the revived use of Securities and Exchange Commission Rule 14a-8, named “investor proposition” (the Rule). The rule has been classified as “the focal point of the investor rights development,” and “a stage for correspondence and change.”The rule permits investors to submit precatory recommendations on the organization’s intermediary articulation without acquiring the cost of sending their own intermediary proclamation. 

Hence along these lines, investor majority rule government had become an essential piece of each organization that can’t be maintained a strategic distance from. In the event that it is maintained a strategic distance from, at that point, it would step by step lead to the breakdown of the framework.

Participation and role of proxy system

The enormous subject of shareholders’ participation in corporate administration exists in a regularly ignored procedural setting that of exposure and information flow. Educated investment is as significant as interest as such. Besides, the differentiation between detached cooperation in a basic endorsement mode and dynamic support in the plan setting sense is a fundamental part of the general subject of investor interest in corporate administration. One path by which the cooperation of the shareholders in the issues of the organization expanded was by the method of proxies. It is significant that in any event from a corporate vote based system viewpoint, there should not be any obstructions to shareholders’ interest in corporate administration in the intermediary procedure. While it can absolutely be contended that more prominent shareholders’ cooperation in corporate administration is important to check the directorial manhandles, this is just one of a few potential contentions for allowing huge shareholders a more prominent job in the corporate dynamic procedure. Expanded shareholders’ interest in corporate administration could likewise create a subsequent potential advantage for greater exposure in the company. A few executives or directors have settled on some incredibly poor choices, in any event from the financial point of view, over protests by shareholders.

Thus there had been instances, that in the case of private deals with activists investors occurs the movement of shareholder democracy had often been surpassed by the special governance interest measures.  

Conclusion

Thus the word company not just means a separate legal entity, but at the same time, it should also attribute to the efforts of individuals or people who are working for the growth and development of the company. Thus a company is a systematic structured and patterned relationship that exists at every stage of the working force. There is supposedly a hierarchical structure in every association, however, there are some basic principles that should never be suppressed: transparency, accountability, and participation. Each and every individual should have proper participation in the company as a result of which proper policies could be formulated for the working of the same. 

References

1. Prem Sikka et al. Better Future of corporate governance, Technical Report, Sept. 2018, at 17.
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3. Micheal Walton, Corporate Governance and Agency Problem- Consequences and efficiency and equity, Application and cases in International Development, 2007, at 5-8, http://www.michaelwalton.info/wp-content/uploads/2011/08/Corporate-governance-and-agency.pdf.
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6. Henry. G. Manne, Mergers and Market for Corporate Control, The Journal For political Economy, Vol. 73, No.2, 1965, at pg. 110-113.
7. Micheal J. Rubach, Institutional Shareholder Activism: The Changing Face of Corporate Ownership, (1999) at pg. 8-9, https://pdfs.semantic scholar.org/be37/255bb4c 70cb 4 3 355f1f6c6b74b1920a71acd.pdf.
8. John H. Matheson & Vilena Nicolet, Shareholder Democracy and Special Interest Governance, https://www.minnesotalawreview.org/wp-content/uploads/ 2019 /04 /Ma th esonNicolet_FINAL.pdf.
9. Vaibhav Sonule, Prof. (Dr.) Bindu Ronald, The Eclipse of Corporate Democracy in India, Vol. 6 Issue 7, 2017, International Journal of Humanities and Social Science Invention, http://www.ijhssi.org/papers/v6(7)/Version-3/A0607030108.pdf.

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