Academic journal article IUP Journal of Corporate Governance

Corporate Governance Mechanisms and Firm Performance: A Survey of Literature

Academic journal article IUP Journal of Corporate Governance

Corporate Governance Mechanisms and Firm Performance: A Survey of Literature

Article excerpt

Introduction

Berle and Means (1932) predicted the evolution of corporations with diffused ownership and control concentrated in the hands of the professional managers. The prediction came true but the separation of ownership and control brought certain problems along with it. The problem and the associated costs are well explained by Jensen and Meckling (1976), according to whom, the owners also called as principals, enter into a contract with the agents (i.e., managers) in order to engage them to run the organization on the behalf of the owners. As both, the agents and the principals are utility maximizers therefore, there are possibilities that the managers may not function in tune with the interests of the owners or shareholders. This problem with this contract is termed agency problem and the costs associated with this problem, agency costs. The agency problem has also been highlighted by Shleifer and Vishney (1997), according to whom, a manager borrows money from the financiers or from the shareholders to put them for productive use. The financiers, in order to ensure that their money is properly utilized, enter into a contract with the managers, because the contract cannot be a complete contract as the residual rights lie with the managers. These residual rights give them the discretion to act the way, they want to. It is therefore possible that they can act against the interests of the financiers. Therefore, it is essential to reduce the managerial opportunism to the maximum extent possible. Hart (1995), Shleifer and Vishney (1997) presented a few mechanisms, called as corporate governance mechanisms to curb or deal with agency problems and managerial opportunism. Research has suggested that corporate governance mechanism deals with the ways in which capital providers guarantee to firms of getting a return on their venture, (Shleifer and Vishney, 1997). They also propose that the corporate governance came into picture basically, for supporting and protecting the investors from the agents, that is, to reduce agency costs.

Cadbury committee (1992) defines corporate governance as a system by which companies are directed and controlled. OECD (2004) defines it as a set of relations among a firm's management, its board, shareholders and stakeholders, which is one of the key elements that improves a firm's performance, and the fluctuation of capital markets, stimulating the innovative activity and development of enterprises.

Dennis and McConnell (2003) also argue in their paper that, to overcome problems in corporate governance, different mechanisms can be applied. These mechanisms can be internal or external, where internal mechanisms operate through the board of directors, ownership structure (managerial ownership). Some of these mechanisms are: board of directors, ownership concentration and disclosure. However, whether these mechanisms actually serve the purpose of protecting the principles and creating value for them, needs to be researched. The value creation can be measured through the performance of the firm. In this paper, we review the literature on the relationship between the three major corporate governance mechanisms namely, board, disclosure and ownership and the firm performance.

Board Characteristics and Firm Performance

According to Perry and Shivdasani (2005), board of directors is one of the most important mechanisms used by the shareholders to monitor management. They state, "Charged with hiring, evaluating, compensating and ongoing monitoring of the management, the board of directors is the shareholder's primary mechanism for oversight of managers". As the board of directors is one of the most important mechanisms to check the erring management, several studies have been conducted to see how the characteristics of the board can control management and therefore enhance the performance of the firm. However, there is no consistent evidence regarding this relationship. Some studies found a positive relationship between board characteristics and firm performance, some report no relationship while, some other studies report a negative relationship between the board characteristics and firms' performance. …

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