Theoretical framework of corporate governance.

Essay by lvpi November 2005

download word file, 2 pages 3.0

Corporate governance practices constantly evolve to meet changing conditions. As a work-in-progress, there is no single universal model of corporate governance. Also, something worth noting is that the structure in corporate governance varies from corporation to corporation. Therefore, experimentation and variety should be expected and encouraged. In addition, corporate governance tends to vary as a function of ownership, business circumstance, competitive conditions, corporate life cycle and numerous other factors. (Millstein et al, 1998)

It has been investigated that effective corporate governance involves a multi-faceted set of activities, which involve institutional investors, insider and outsider board membership and equity ownership, board committees, the market for corporate control, and so on.(Keasey and Wright, 1997).

The problem of corporate governance arises when ownership and control are separated, for instance between shareholders and managers. The owners bear the residual risk and receive residual rewards. Unlike the owners, the managers control the decision-making process and therefore make all the decisions, which influence those risks and rewards.

Since the managers and the owners may have different objectives and the owner are likely to lack complete information about the behavior and decisions of the manager, the "agency" problem occurs. As an attempt to solve the problem, the "principal", the owner, has to seek an efficient way to ensure that the "agent", management, acts in the principal's rather than the agent's best interest. When the principal does not have full information about the circumstances and decision-making of the agent, they must design a contract between them, which provides the agent with appropriate incentives. In the meanwhile, to be successfully monitored, the unsatisfactory behavior of the agent will have to be punished. (OECD, 1998)

As far as the board committees are concerned, there are differing views about what committees are required, depending on the...