In simple terms, Governance means “the process of decision-making and the process by which decisions are implemented”. Thus governance related to large businesses is called Corporate Governance. Firms are social entities and have certain social obligations. A firm needs coordination between many groups of people known as stakeholders. The stakeholders are the owners, the managers, the workers, the suppliers, the creditors, the customers, the competitors, the government, and even the society at large. The stakes of various stakeholders are:
Good Corporate Governance requires that the firm:
The corporate form of business raises large capital from public; therefore there are millions of shareholders contributing small capital. Since contribution of shareholder is small, it is not practically possible for shareholders to run the day-to-day management of business. Thus in between owners and business, a corporate form of business introduced a new entity called Management. This management consists of professional managers who manages the company and take the important decisions.
We have seen that in corporate form of business, there is separation of ownership and business. This creates a unique type of problem known as Agency Problem. The problem of Principal-Agent is universal. Agents (Managers) are expected to work for the benefit of principal (owners) and take decisions that are beneficial for the principal. However often agents take decisions that are beneficial for themselves. When ownership and business is separated, the managers are expected to act for the benefits of the owners. However, there is chance that managers may pursue certain alternative objectives that are beneficial to themselves rather than owners. The conflict is called Agency Problem.
One solution to mitigate the agency problem is to appoint the honest and ethical managers. But question is how to determine whether a manager is honest/ethical or not. Thus there is need to do something beyond appointment of managers.
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