Corporate Governance 2023/20

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THE UNIVERSITY OF BAMENDA

FACULTY OF ECONOMICS AND MANAGEMENT SCIENCES

DEPARTMENT OF ACCOUNTING (Conversion Master’s Program)

FIRST SEMESTER 2023/2024

COURSE: Internal Auditing and Corporate Governance

Section B: Corporate Governance

Lecturer:

Dr. Tayong Desmond M (Senior Lecturer – Uba)

Dr. Kueda Wamba B (Senior Lecturer – Uba)

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COURSE PLAN

CHAPTER ONE: GENERAL INTRODUCTION AND BACKGROUND

1.1. Background

1.2. Definition of concepts: Corporate Governance

1.3. The origin and necessity of corporate governance

CHAPTER TWO: THE THEORIES OF CORPORATE GOVERNANCE

2.1. The works of Berle and Means

2.2. The contractual theories of corporate governance

 The property right theory

 The agency theory

 The transaction cost theory

 Other theories

CHAPTER THREE: THE MECHANISMS AND PRINCIPLES OF CORPORATE

GOVERNANCE

3.1. The mechanisms of corporate governance

3.2. The principles of corporate governance

CHAPTER FOUR: INTERNATIONAL COMPARISM OF CORPORATE GOVERNANCE

PRACTICES

4.1. Introduction

4.2. The anglo-saxon model

4.3. The german/network model

4.4. The Japanese model

4.5. The French model

4.6. The African model

CHAPTER FIVE: COMPTEMPORARY ISSUES IN CORPORATE GOVERNANCE

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CHAPTER SIX: CASE APPLICATIONS

CHAPTER ONE: GENERAL INTRODUCTION

I. THE BACKGROUND OF CORPORATE GOVERNANCE

The past two decades have witnessed an ongoing platform of research in the area of corporate
governance. The term ‘Corporate Governance’ is becoming popular as it is increasingly being
used by practitioners, academia and the press. The term Corporate Governance originates from a
Greek work ‘Kubernan’ which means to ‘pilot a ship’. This term thus is a medieval one used in
the 13th century to imply the government. It was only in the 14 th century that this term was finally
distinguished from the term ‘government’.

In 1937, the term ‘governance’ reappeared in the work of Ronald Coase (the nature of the firm).
Since then, the definition and content of this term has been evolving. It should be noted that there
is no universally accepted definition of corporate governance but at least looking from the works
done by experts at the World Bank, we can retain the following definition for corporate
governance;

Governance can be defined as the procedure and institutions through which power is exerted
within a country. This includes:

 The procedure by which the holders of power are chosen, maintained, controlled and
replaced.
 The capacity of the government to effectively manage its resources and formulate,
apply and impose respect for quality policies and regulations.
 The respect of the state and its citizens towards institutions involved in economic and
social activities and the relationship between them.

With the advent of the 21 st century, the facet of corporate governance was completely changed
with the bankruptcy of leading companies such as ENRON (USA), PARMALAT (ITALY) and
VIVEND (FRANCE).

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1. DEFINITION OF CORPORATE GOVERNANCE

It is very difficult to have a unanimous or universal definition of what the corporate governance
of an enterprise is. Shareholders, managers and boards of directors are among the most active
and most decisive stakeholders in every business institution:

1.1. Shareholders

These are the financial suppliers of the business as they make available part of their property
right to managers against remuneration (dividend).

1.2. Managers

They are linked to the shareholders by a contract and are called upon to exercise the power given
to them in order to maximize the interest of the shareholders.

1.3. Board of directors

They are called upon to evaluate and ratify strategic decisions as well as control the activities and
managerial actions of the managers on behalf of the shareholders.

Corporate governance can therefore be defined around these three components as all mechanisms
and structures of allocation, exercise and control of managerial powers in an organization, since
managers are always seen as opportunistic and as such, always looking to satisfy their personal
interest first and at times even to the detriment of the institutions they [Link] exist many
other definitions of corporate governance with each of them presenting the problem of
governance in a significantly different way. We can discuss the following:

Shleifer and Vishny (1997) defined corporate governance as all the means which the suppliers of
capital use to guarantee the profitability of their invested resources. This definition is centered on
the shareholders as the exclusive beneficiaries of the value creating capabilities of an enterprise.
Charreaux (1997) provided a wider definition as the totality of means which governs the
behavior of managers and delimits their discretionary power. Corporate governance from this
definition is seen as controlling the managers and maximizing the shareholder’s value at the
same time.

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Also, according to Rajan and Zingales (2000), governance is seen as the mechanisms of
allocating and controlling and exercising power or hierarchical authority. Unlike the other
authors, these authors insist that corporate governance is centered on conflict prevention and the
governance of the utility function. According to Addelwahed (2003), corporate governance is the
organization of formal power between the different stakeholders of the enterprises.

According to the Cadbury report (2010), corporate governance is the system by which companies
are directed and controlled. Generally, it refers to the processes, structures, policies and laws that
govern the management of a company. It also refers to the way the board oversees the operations
of a company and about how board members are accountable to the company and its
shareholders.

2. THE ORIGIN OF CORPORATE GOVERNANCE: FROM A

CAPITALIZED FIRM TO A MANAGERIAL FIRM
At the beginning of the 19th century, enterprises had as main objectives, the optimal
transformation of factors of production (inputs) into a certain quantity of products (output). The
enterprise was thus seen as a black box. That is, a production function aimed at transforming
inputs (raw materials) into outputs (products and services). This situation was justified by the
environment then which was stable and less competitive. The classical managers at that time had
as mission, to set objectives, control results and determine variations. He is also the owner of the
business since he belongs to the controlling family.

At the end of the 19th century, the development of businesses, the evolution of the environment
and technological advancements brought in new regulations for the management of businesses.
As such, businesses had to be restructured. In order to increase their profitability of the business,
the management style had to change in order for the business to remain competitive. The
enterprises had to work towards large scale production with the aim of reducing cost and
maximizing profit while being different from other competitors. The increase in the size of the
business, the evolution of the business environment and the use of external sources of finance to
finance new business structures let to the slow disappearance of the capitalist firm in favor of the
managerial firm characterized by the separation of ownership from control. Berle and Means

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(1932) in studying 200 American firms concluded that it is this separation of ownership from
control which brings in the concept of ‘conflict of interest’.

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CHAPTER TWO:

THEORIES OF CORPORATE GOVERNANCE

The study of corporate governance can be viewed from many origins, but for this work, we will
look at the finance and economic points of view where the different theories will be based on the
principle of efficiency. That is, the efficiency of the different governance mechanisms put in
place to align the interest of the managers with those of the company (shareholders) and other
stakeholders.

2.1. The works of Berle and Means

In the middle of the 19th century in Europe and USA, the development of very large businesses
(public enterprises) implied a more significant separation between the managers and the widely
dispersed shareholders. The importance of this separation was highlighted by Berle and Means
(1932). According to these authors, one of the reasons for the dispersion of shareholders is that
each one of them posses just a vote which is almost insignificant compared to the number of
shareholders. As such, he loses control over the enterprise. The shareholders are thus passive and
as such, the value of their shares depends on the managers and other stakeholders. According to
Berle and Means (1932), the enterprise tries to be a specific entity and different from its owners.
As such, the question of corporate governance becomes very important in controlling the
activities of managers on behalf of the owner.

2.2. The contractual theories of corporate governance

This model can be summarized under the following principle: the relationship between the
individuals in the enterprise can be explained by the contact that links them together. The
enterprise is therefore a nexus of contracts. These contractual theories are the property right
theory, the agency theory, the transaction cost theory, the stewardship theory and the stakeholder
theory.

2.2.1. The property right theory

The question of property right has been the question of controversy since the 19 th century. This is
the main foundation of the capitalist approach to corporate governance. The theory was only

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formulated in the 1960s with the authors such as Ronald Coase (1960), Armen Alchian (1959,
1961, 1965), Herold Demsetz (1966, 1967) and Alchian and Demsetz (1972).

Property right according to Demsetz (1967) is seen as all the means which permit individuals to
know what to expect in their relationship with other members of their community. This
expectation is materialized by laws, customs and beliefs of the society.

To give a precise definition of property right, we will have to look at it from two dimensions: the
right of residual claim and the right of control. Holding the residual right to an asset implies
having the residual right to profits coming in as a result of the exploitation of that asset. The
individual with such rights in an organization is seen as the owner or shareholder. Also, the right
of residual control is seen as the right concerning the usage of an asset. To be more precise,
holding the rights to an asset implies being able to use the asset, change its form, change its
substance, transfer the right by partial or complete sale of the asset.

From the legal point of view, property right can be defined from three points of view:

 the right to use an asset (usus)

 the right to profits from the exploitation of an asset (fructus)
 the right to dispose off and asset (abusus)

The property right theory is based on the following hypothesis:

 The individuals are perfectly rational. They maximize their utility function under the
constraints imposed by the economic system they eveolve in and the rights they have.
 The preferences of agents are seen in their behavior in the market
 They exist asymmetry of information and transaction costs

From this theory, the enterprise is no longer considered indivisible and united entity but is seen
as a combination of contracts between individuals having their own interest (objectives) which
maybe different from those of the company.

2.2.2. The agency theory

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Corporate Governance is a concept emerging from the agency theory, as to synchronize between
the owner and management’s interest. Corporate governance has traditionally been associated
with the “principal-agent” or “agency” problem. A “principal-agent” relationship arises when the
person who owns a firm is not the same as the person who manages or controls it. For example,
investors or financiers (principals) hire managers (agents) to run the firm on their behalf.
Investors need managers’ specialized human capital to generate returns on their investments, and
managers may need the investors’ funds since they may not have enough capital of their own to
invest. In this case therefore, there is a separation between the financing and the management of
the firm. I.e. there is a separation between ownership and control (Berle and Means, 1932).

Based on the agency theory introduced by Jensen and Meckling (1976), it is shown that the
separation of ownership and control will result in the agency relationship when the principal
deputise their authority towards the agent to execute some services of the principals that are
conceptualized in a series of contracts. Such separation can lead towards conflicts as a result of
the conflicts of interests which generally occur in almost all individual activities in the principal-
agent hierarchy. The agency conflicts can be alleviated with contracts, although not all aspects
can be stated in such contracts.

Assuming that the principal and the agent are mainly concerned about maximizing their personal
wealth, agency theory believes that the agent may not always act in the best interests of the
principal. Added to this, long term contingencies are also not amenable to be predicted, which
makes the principal build only incomplete contracts with the agent. Note that incomplete
contracting set up makes the study of agency relationship critical. The principal needs to set
appropriate incentives for the agent and also establish monitoring mechanisms to control any
deviant activities of the agent, which are classified as the ‘monitoring’ is comprehensive as it
includes controls, such as setting budget restrictions and operating rules, beyond merely
observing and measuring the agent’s performance.

Furthermore, the agent may also spend resources in guaranteeing that he or she would not take
actions which would harm the principal (an example is the bond provided by the agent) which is
included under ‘bonding costs’. Even after incurring monitoring and bonding costs, the principal
may suffer loss since the agent’s decisions may be different from those that would maximize the

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principal’s welfare. The monetary equivalent of such loss is classified as the ‘residual loss’. In
summary, agency costs are the total of 1) monitoring costs, 2) bonding costs and 3) residual loss.

Williamson (1988) further clarifies that residual loss is the key cost that the principal would seek
to reduce. To help achieve this objective, the principal incurs monitoring costs and makes the
agent incur bonding costs. Hence, the “irreducible agency costs are the minimum of these three
costs”. Thus, corporate governance is needed to help the corporate synchronizes the interests of
all members of the organization (Hart, 1995). Corporate governance is a law system, rules and
factors that control the corporate operations (Gillan, 2006).

2.2.3. Transaction cost theory

Transaction cost theory can be viewed as part of corporate governance and agency theory. It is
based on the principle that costs will arise when you get someone else to do something for you.
These transaction costs include the costs of information, search, negotiation and re-negotiation,
contracting, and enforcement (Williamson, 1985). Transaction cost theory can be applied to a
discussion of governance by viewing it as an alternative variant of the agency understanding of
governance assumptions. It describes governance frameworks as being based on the net effects
of internal and external transactions, rather than as contractual relationships outside the firm (i.e.
with shareholders). Transaction costs will occur when dealing with another external party;
bargaining and decision costs to purchase the component; Policing and enforcement costs to
monitor quality.

The way in which a company is organized can determine its control over transactions, and hence
costs. It is in the interests of management to internalize transactions as much as possible, to
remove these costs and the resulting risks and uncertainties about prices and quality. For
example a beer company owning breweries, public houses and suppliers removes the problems
of negotiating prices between supplier and retailer. Transaction costs can be further impacted by
the following: bounded rationality which is our limited capacity to understand business
situations, which limits the factors we consider in the decision and opportunism which are
actions taken in an individual’s best interests, which can create uncertainty in dealings and
mistrust between parties.

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The significance and impact of these criteria will allow the company to decide whether to expand
internally (possibly through vertical integration) or deal with external parties. The variables that
dictate the impact on the transaction costs are: frequency, which determines how often such a
transaction is made; uncertainty which shows that long term relationships are more uncertain,
close relationships are more uncertain, lack of trust leads to uncertainty; and asset specificity
which shows how unique the component is for your needs. Transaction costs exacerbate the
problems associated with setting a complex bilateral, long term, and complete contract.
Complete contracts would contain all information about the future and instructions for every
possible state of the world1. In conclusion, if complete contracts were feasible, all transactions
would take place in the markets and not within a corporate hierarchy.

Transaction cost theory and agency theory essentially deal with the same issues and problems.
Where agency theory focuses on the individual agent, transaction cost theory focuses on the
individual transaction.

 Agency theory looks at the tendency of directors to act in their own best interests,
pursuing salary and status. Transaction cost theory considers that managers (or directors)
may arrange transactions in an opportunistic way.
In the context of contracts, frequently one of the parties has an information advantage.
The problem of asymmetric information emerges before and after a contract has been
written. Ex-ante, the qualities of the parties involved; i.e., the risk of choosing a bad
counterparty. The second problem of asymmetric information occurs after the completion
of the contract. Expost, moral hazard can be an issue. The contracting parties may not
behave as expected, and the (hiden) action cannot be observed.
 The corporate governance problem of transaction cost theory is, however, not the
protection of ownership rights of shareholders (as is the agency theory focus), rather the
effective and efficient accomplishment of transactions by firms.

1
In the context of contracts, frequently, one of the parties has an information advantage. The problem of
asymmetric information emerges before and after a contract has been written. Ex-ante, the qualities of the parties
involved, that is their characteristics and intentions are often observable (Arrow, 1984). There is risk of adverse
selection; that is, the risk of choosing an adverse counterparty. The second problem of asymmetric information
occurs after the completion of the contract. Ex-post, moral hazard can be an issue. The contracting parties may not
behave as expected and their ‘hidden’ action connot be observed.

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2.2.4. Stewardship Theory

Stewardship theory has its roots from psychology and sociology and is defined by Davis,
Schoorman & Donaldson, (1997) as “a steward protects and maximizes shareholders wealth
through firm performance, because by so doing, the steward’s utility functions are maximized”.
Shortly, how does corporate governance operate under stewardship theory? Owners still establish
the cardinal objectives for the sake of which the corporation exists. But they are also responsible
for providing managers with an environment, suitable for developing human potentialities of
forming societies to collaborate in meaningful work. Managers act as stewards or caretakers;
they act as if they were owners in terms of the care and concern expressed for work rather than
merely executors of the interests of others. In other words, the alienation implied in agency
theory (acting not out of self but for another), disappears as the managers and employees of the
corporation reabsorb the agent function.

Stewardship approaches are primarily value-based. They (1) identify and formulate common
aspirations or values as standards of excellence, (2) develop training programs conducive to the
pursuit of excellence, and (3) respond to values “gaps” by providing moral support. In this
perspective, stewards are company executives and managers working for the shareholders,
protecting and making profits for the shareholders, unlike agency theory.

2.2.5. The Stakeholder Theory

Another theory on which corporate governance finds its basis is the stakeholder’s theory. It was
embedded in the management discipline in 1970 and gradually developed by Freeman (1984)
incorporating corporate accountability to a broad range of stakeholders. Stakeholders are those
who have a stake or claim in some aspect of a company’s products, operations, markets, industry
and outcomes. Stakeholders can influence and are influenced by businesses. Stakeholders are
thus classified into two types namely: primary stakeholders whose continued association is
necessary for a firm’s survival (Employees, customers, investors, governments and communities)
and Secondary stakeholders who are not essential to a company’s survival (media, trade
associations, and special interest groups). Stakeholder theory can be defined as “any group or
individual who can affect or is affected by the achievement of the organization’s objectives”. To

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Freeman (1984), the internal and external stakeholders of a company can be shown in the Figure
below:

Figure 1 : Internal and external stakeholders of a company

Source: Adapted from the works of Freeman (1984)

The firm performance is affected by the degree to which the firm understands and addresses
stakeholder demands conducting activities like generation of data about stakeholder groups,
distribution of the information throughout the firm, organization’s responsiveness to this
intelligence.

Generally, to implement the stakeholder perspective, firms should do the following: assessing the
corporate culture, identifying stakeholder groups, identifying stakeholder issues, assessing
organizational commitment to social responsibility, identifying resources and determining
urgency and giving stakeholders feedback. To ensure participation of a wider constituent groups
(with economic and/or social stakes in corporate activities such as employees, customers,
suppliers, stockholders, banks environmentalists, government, to name but a few) in the
governance process, assuring that their wide range of interests are taken into account by giving
shareholders increased rights to participate in important management decisions by:

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(a) Change in the composition of boards by including more outside directors to alleviate concern
boards are too subservient to management.

(b) Employee representation at some level in corporate governance.

(c) Reinforce of government rules and regulation over issues like insider trading, hostile takeover
Buchholz (1989).

Stakeholder approaches combine compliance and value-based approaches. In compliance,

corporate officers define a moral and legal minimum; this consists of the minimum set of rules
necessary for stakeholder coexistence. Beyond this, value-based approaches seek to create
common, broader objectives and aspirations that can unite the different stakeholders in the
pursuit of excellence. Stakeholder approaches need both the compliance approach to gets things
started and the values-based approach sets them on the path to excellence. Donaldson and
Preston (1995) offered four central theses related to stakeholder theory:

(a) Stakeholder theory is descriptive in that it offers a model of the corporation;

(b) Stakeholder theory is instrumental in offering a framework for investigating the links
between conventional firm performance and the practice of stakeholder management;

(c) Although stakeholder theory is descriptive and instrumental, it is more fundamentally

normative. Stakeholders are identified by their interests and all stakeholder interests are
considered to be intrinsically valuable;

(d) stakeholder theory is managerial in that it recommends attitudes, structures, and practices,
and requires that simultaneous attention be given to the interests of all legitimate stakeholders;
where instrumental justification: success in satisfying multiple stakeholder interests constitutes
the ultimate test of corporate performance, with monitoring devices that reduce information
asymmetry, and enforcement mechanisms including law, exit and voice, and emphasis of
fairness. And normative justifications: a pluralistic theory of property rights supports various
groups a moral interest or stake in the affairs of the corporation (Donaldson & Preston, 1995.)

Unlike agency theory in which the managers are working and serving for the stakeholders,
stakeholder theorists suggest that managers in organizations have a network of relationships to
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serve-this include the suppliers, employees and business partners. And it was argued that this
group of network is important other than owner-manager-employee relationship as in agency
theory (Freeman, 1999).

2.2.6. Shareholder Theory

The origins of the ideas shaping shareholder theory are more than 200 years old, with roots in
Adam Smith‘s (1776) ‘The Wealth of Nations’. In general, shareholder theory encompasses the
idea that the main purpose of business lies in generating profits and increasing shareholder
wealth. Modern proponents of shareholder theory espouse three tenets from Smith, which are
the importance of free markets; the invisible hand of self-regulation; and the importance of
enlightened self-interest.

The shareholder theory in its current form was proposed by Milton Friedman (1970) and he
states that the sole responsibility of business is to increase profits. It is based on the premise that
management is hired as the agent of the shareholders to run the company for their benefit, and
therefore they are legally and morally obligated to serve their interests. The only
qualification on the rule to make as much money as possible is in conformity with the basic rules
of the society, both those embodied in law and those embodied in ethical custom. The
shareholder theory is now seen as the historic way of doing business with companies realizing
that there are disadvantages to concentrating solely on the interests of shareholders. A
focus on short term strategy and greater risk taking are just two of the inherent dangers
involved. The role of shareholder’s theory can be seen in the demise of corporations such
as Enron and WorldCom where continuous pressure on managers to increase returns to
shareholders led them to manipulate the company accounts.

Two influential and recent schools of thought fall under the broad umbrella of
shareholder-based theories: transaction cost economics (TCE) and agency theory. Like
shareholder theory, each focuses on behaviors that can maximize firm efficiency: TCE focuses
on the importance of corporate hierarchies and monitoring employee behavior to minimize self-
interested behavior; agency theory focuses primarily on the principal vs. agent (shareowner vs.
manager) relationship in publicly traded firms, and how to best align the competing interests of
the two parties to maximize firm value. Both TCE and agency theory have a gloomy vision of
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human self-interest. Both assume that human beings are opportunistic, and, thus, will put their
own interests before the firm‘s.

In terms of the theoretical perspective adopted, the agency theory has by far dominated thinking
on governance of family firms, Goel et al. (2014), Nordqvist et al. (2014), Villalonga et al.
(2015). Most of the works related to governance in family firms rely on agency theory. More
recently, some researchers have conbined the competing theories of agency and stewardship
argueing that they are complementary and better explain how governace affects the performance
of enterprises. Most of the studies agree on the importance of concentrated ownership as an
important element that makes family enterprises out perform their non family counterperts,
(Miller and Le Breton-Miller 2006, Prenice et al. 2011, Parada et al. 2016).

In recent review, Goel et al. (2014) note that other approaches have been recently used but
scarcely incorporated into the family business governance studies such as social and relational
capital (Jones et al. 2003).

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CHAPTER THREE

MECHANISMS AND PRINCIPLES OF CORPORATE

GOVERNANCE

3.1. CORPORATE GOVERNANCE MECHANISMS

Effective corporate governance is essential if a business wants to set and meet its strategic goals.
A corporate governance structure combines controls, policies and guidelines that drive the
organization toward its objectives while also satisfying stakeholders’ needs. A corporate
governance structure is often a combination of various mechanisms. Traditionally, the theoretical
literature identifies two mechanisms which are the internal and external mechanisms (Charreaux
et Pitol, 1991). Jensen (1993) also identifies four basic categories of individual corporate
governance mechanisms which are: legal and regulatory mechanisms, internal control
mechanisms, external control mechanisms, and product market competition. But many
researchers often categorize corporate governance mechanisms (Gillan, 2006; Rezaee, 2007
ampng others) in to the internal mechanisms derived from the board of commissioners, internal
control, and internal audit functions. The quality of the internal mechanism is closely related to a
better corporate performance (Aman and Nguyen, 2008). Whereas the external mechanisms is
derived from the capital market, corporate control market, labor market, state status, court
decisions, stock holders, and investor activities.

3.1.1. Internal Corporate Governance Mechanisms

The foremost set of controls for a corporation comes in its internal mechanisms. These controls
monitor the progress and activities of the organization and takes corrective actions when the
business goes off track. Maintaining the corporations larger internal control fabric, they serve the
internal objectives of the corporation and its internal stakeholders (employees, managers and
owners). These objectives include smooth operations, clearly defined reporting lines and
performance measurement systems.

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However a lot of research has been carried out between corporate governance and firm
performance. Examples are the study of Kajola (2008) who uses four corporate governance
mechanisms (board size, board composition, chief executive status and audit committee) for his
study. Also, the ICM2 includes the oversight of management, independent internal audits,
structure of the Board of Directors into levels of responsibility, segregation of control and policy
development. The internal mechanism is also divided into five basic categories, they are: the
board of commissioners (roles, structures and incentives), managerial incentives, capital
structure, constitutions and corporate regulations, and internal control system (Gillian, 2006). In
our study, we are going to use the BODs, the shareholders and executive compensation.

3.1.2. Board of Directors

The board of directors is elected by the shareholders at the general meeting and represents their
interests. The board serves as a bridge between owners and managers; its duty is to protect
shareholders’ interest (Veliyath, 1999). The board of directors is the individuals responsible for
representing the firm’s owners by monitoring top-level managers’ strategic decisions. The
BODs, has a legal authority to hire, fire and compensate top management and safeguards
invested capital. The BODs plays a major role in the corporate governance framework and the
strategic guidance. The OECD principles of Corporate Governance (2004) describe the
responsibilities of the board; some of these are summarized below3:

 Board members should be informed and act ethically and in good faith with due diligence
and care, in the best interest of the company and the shareholders.
 Review and guide corporate strategy, objective setting, major plans of action, risk policy,
capital plans, and annual budgets.
 Oversee, compensate, monitor and replace key executives and oversee succession
planning.
 Align key executive and board remuneration (pay) with the longer-term interests of the
company and its shareholders.
 Ensure a formal and transparent board member nomination and election process.

2
Internal corporate governance mechanisms
3
[Link]

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 Ensure the integrity of the corporations accounting and financial reporting systems,
including their independent audit.
 Ensure appropriate systems of internal control are established.
 Oversee the process of disclosure and communications.
 Where committees of the board are established, their mandate, composition and working
procedures should be well-defined and disclosed.

Past research has generally examined three characteristics of boards, namely, the size of the
board, the proportion of outsiders on the board, and the number of board meetings. Board of
Directors characteristics may also include the following elements: board composition, separation
of chairmanship and CEO role; Board Committees; Foreign Directors and their effect on
corporate performance. We will base our study on the following:

a) The size of the Board of Directors

Board size plays a pivotal role in mitigating agency costs and in affecting the firm performance.
Board size seems to differ from one country to another. Every board should examine its size,
with a view to determine the impact on its numbers. There is no ideal size for a board but the
right size for a board should be driven by how effectively the board is able to operate as a team
(Conger et al., 1998). The board members shoulder the responsibility of disciplining the
management. Pfeffer (1972), Forbes and Milliken (1999), Zahra and Pearce (1989) stated that a
larger board has advantages such as sharing of management and expertise. A large board has the
capacity to oppose any illogical decisions made by the CEO. Pfeffer and Salancik (1978) drew
our attention to the Resource Dependency theory which highlighted the importance of board size.
The theory suggested that the external parties possess resources which the firm feels critical for
the achievement of its internal objectives. The Board of Directors act as agents in acquiring the
optimum resources and a larger board is assumed to be more efficient in the adoption of best
strategies for obtaining the resources that are crucial for a firm’s success (Johnson, Daily, &
Ellstrand, 1996).

However, another main argument following a board size is that relates itself with the
agency theory and a larger board creates agency costs and does not function properly. Studies
reveal that a free rider problem is usually prevalent in a large board as the board members tend to
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make delays in making good decisions and in actively supervising the firm (Jensen, 1993). The
board of directors plays a vital role in the realization of corporate governance. They are highly
responsible for protecting the interest of shareholders, reducing agency cost and in supervising
fraudulent managers. We must not overlook the negative end in large boards as there is a
tendency for any cost to evolve amongst these members. This negativity is absent in a smaller
board as highlighted by Yermack (1996). Based on the above assumptions, many studies evolved
showing both the facets existing between board size and corporate performance.

b) Outsiders in the Board of Directors

It is widely accepted that corporate governance mechanisms may perhaps want to restrict
potential entrenchment effects liked with high ownership levels. Outsiders in the board are one
such examples of governance mechanisms. Outside board members are not tangled to the routine
operations of the firm and hence, they are likely to cogitate more independently concerning the
firm’s performance. Their experiences help generate new perspectives and ideas and can increase
earnings performance (swamy 2007). The correlation between the proportion of outsiders in the
board and performance of the firm has been the objective of many studies.

c) Board Composition

Boards mostly compose of executive and non-executive directors. Executive directors refers to
dependant directors and non-Executive directors to independent directors (Shah et al., 2011). At
least one third of independent directors are preferred in board, for effective working of board and
for unbiased monitoring. Dependant directors are also important because they have insider
knowledge of the organization which is not available to outside directors, but they can misuse
this knowledge by transferring wealth of other stockholders to themselves (Beasly, 1996).

Based on the independent board, the board is composed of members who are not executives of a
company, or shareholders, or blood relatives or in-law of the family (Gallo, 2005). An
independent board is generally composed of members who have no ties to the firm in any way,
therefore there is no or minimum chance of having a conflict of interest because independent
directors have no material interests in a company. Dalton, Daily, Ellstrand, & Johnson (1998),
Jocobs (1985) stated that independent directors are important because inside or dependent

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directors may have no access to external information and resources that are enjoyed by the firm’s
outside or independent directors (e.g., CEOs of other firms, former government officials,
investment bankers, social worker or public figures, major suppliers). Moreover, for
advice/counsel inside or dependant directors are available to the CEO as a function of their
employment with the firm; their appointment to the board is not necessary for fulfillment of this
function.

Based on the dependent board, dependent board members are associated with or employed by the
company, for which they receive remuneration or salary. These directors are mostly working in
upper levels of management of a company or have a vested interest in the company. Dependent
directors have a full time job with the firm. As compared to outsider knowledge of the
organization which can be a benefit because they know batter about an organization, but they can
misuse this knowledge by transferring wealth of other stockholders to themselves (Beasly, 1996).

d) Board Meetings

According to the requirement of the Revised 2007 Malaysian Code on corporate governance,
companies are encouraged to have regular board meetings for discharging duties and
responsibilities. Also, it is mandatory for the board to disclose the number of board meetings
held in a year and details of the attendance of each individual director in respect to meetings
held. Frequency of Board meetings is considered to be an important way of improving the
effectiveness of the board (Conger & Lawler, 2009) and (Adam & Ferreira, 2009). It is argued
that board meetings and attendance of the meetings are considered to be important channels
through which directors obtain firm specific information and able to fulfill their monitoring role.
A study conducted by Francis et al., (2012) indicated that firms with poor board attendance at
meetings perform significantly worse than board which has good attendance during financial
crisis. In addition, Ntim and Osei (2011) conducted a study in South Africa which also suggested
similar findings between the frequency of board meetings and corporate performance where
boards that meet more frequently tend to generate higher financial performance.

On the other hand, there are researchers that consider board meeting not necessarily useful due to
the limited time non-executives spend with the company and considers such time could be better
utilized for a more meaningful exchange of ideas with the management (Vafeas 1999). Also,
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frequent meetings involve managerial time and increase travel expenses, administrative support
requirements and directors’ meeting fees. This may affect enterprise activities within the firm as
resources are being channeled towards less productive activities (Evans et al. 2002). Drawing on
the arguments from the above, there have been inconclusive findings on the frequency of board
meetings with firm’s performance where this study seeks to address. In addition there is a heavy
concentration of existing studies on developed countries such as Europe and North America
which have different institutional context and corporate governance practices where the
effectiveness of board meetings on firm performance can be expected to be different from the
developing countries.

3.1.3. Shareholders

Shareholders do, at least partially, monitor the management themselves. They have the right to
the board of directors. However, the ownership of firms is commonly too fragmented for
shareholders to be motivated to take action on issues. Because of free-riding co-owners,
individual investors are rather passive. In contrast, large shareholders, so-called block holders or
controlling shareholders, usually have an incentive to actively monitor management. However,
as the controlling shareholders gain influence, other conflicts might emerge. The interests of
controlling shareholders and minority shareholders might collide. Controlling shareholders might
only act on issues that are beneficial for them. In this case, a trade-off evolves between weak and
excessively powerful shareholders.

3.1.4. Executive Compensation

In contrast to the two monitoring devices mentioned before, executive compensation can be used
to incentivize the management. Variable compensation (“pay-for-performance”) can align the
interests of both the management and the shareholders (Jensen and Meckling, 1976).
Performance-based remuneration is designed to relate some proportion of salary to individual
performance. It may be in the form of cash or non-cash payments such as shares and share
options, or other benefits. Such incentive schemes, however, are reactive in the sense that they
provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic
behaviour. However, one important condition for this mechanism to work properly is the fact
that the manager’s performance and quality is reflected in the market price, and this requires an
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efficient capital market. In fact, executive compensation nowadays is rather seen as an agency
problem than a governance device. Overly powerful corporate managers are empowered to
dictate the level and the configuration of the salary to a seemingly helpless board.

3.1.5. The Audit Committee

The role of the audit committee by and large can be summarized as:

1. Over seeing financial reporting and accounting

2. Overseeing the external auditors
3. Over seeing regulatory compliance
4. Role in monitoring the internal control process
5. Over seeing risk management.

In general, the audit committee has atleat 3 members with 2/3 of them being non-executive
independent directors (swamy 2009). The number of outsiders in the audit committee is largely
seen as an indication of independence. In view of this, outsiders in the audit committee play a
very significant role in ensuring corporate governance practices in the area of auditing.

3.2. External Corporate Governance Mechanisms

External corporate governance mechanisms are controlled by those outside an organization and
serve the objectives of entities like regulators, governments, trade unions and financial
institutions. These objectives include adequate debt management and debt compliance. External
mechanisms are often imposed on organizations by external stakeholders in the form of union
contracts or regulatory guidelines. Typically, companies report the status and compliance of
ECMs to external stakeholders. ECMs can be divided into five categories, they are: law and
regulations, market, capital market information and analysis, accounting market, finance and
law, and special sources of external control (Gillian, 2006).

3.2.1. The General Assembly

This is seen as the assembly of all the members of an organization who come together with the
managers and the board of directors at the level of decision making. Generally considered as an
annual meeting point, it gives the opportunity for managers to inform shareholders on their
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management of the institution and the later to vote modifications for the proper functioning of
the institution.

The objective of the general assembly is to examine the accounts of the previous year and to take
decisions concerning the board of directors as well as deciding on the distribution of profits. It is
therefore considered:

 The decision center of the organization

 The sovereign body of the organization
3.2.2. The Debt Holder as an External Corporate Governance Mechanism

Debt holders are the external parties who give loans to corporations and can also function as the
corporate governance mechanism. Jensen and Meckling (1976) states that loans cause a
bounding mechanism for the managers to bring good outcomes for the stockholders, by not
creating an opportunity to deviate from the corporations’ free cash flow. The bigger the loans,
the more cash the corporations will have to pay for the interest and installment. Loan taking by
the manager will cause risks to the corporations if the managers fail to show an effective
performance. Thus, the use of loan can change the management’s monitoring from the
stockholders to the creditors.

According to Jensen (2000), the use of loans as a financial source should go along with the debt
covenant as a payout requirement to stimulate the managers’ discipline and to limit activities that
may destroy the recovery of the loan. John and Senbet (1998) say that a debt contract will make
the managers work as being part of the owners by making investment decisions and optimal
financing, in order to maximize the corporate value for the owners. The existence of debt
holders, especially from the banking institution collects money from the investors, lend and
monitor the agent as a part of itself. Debt holders’ monitoring and screening activities will give
both positive and negative outcomes for the external party, for the other creditors and
stockholders (Triantis and Daniels, 1995).

3.2.3. Market for Corporate Control and Takeover Defenses

Market for corporate control, including the fear of hostile takeovers, can also discipline the
management (Manne, 1965; Jensen and Ruback, 1983). This mechanism is particularly important
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in Anglo-Saxon countries where the ownership of the firm is commonly dispersed and the capital
markets efficient. If stock prices reflect the ability of the management, poor managerial decisions
lead to falling prices and, thereby, increase the probability of the firm becoming a takeover
target. Thus, managers adopt actions that sustain firm value. However, the board can also install
takeover defenses to mitigate this mechanism. Takeover defenses differ substantially across
countries and firms, but their objectives is always the same. They decrease the probability of a
hostile takeover, which has the consequence of entrenching the management.

3.2.4. Competition

Competition is a natural mechanism that prevents wasting money and acts on three main
markets. Firstly, as discussed before, the market for corporate control exposes badly run
companies to the danger of a hostile takeover. Secondly, the managerial labour market allows
managers to signal their ability in order to increase their market value and prestige (Fama, 1980).
Thirdly, competition in the product market leads to an economization of resources in order to
remain competitive and in the market (Beiner et al., 2009).

3.3. Principles of Corporate Governance

Contemporary discussions of corporate governance tend to refer to principles raised in three
documents released since 1990: the Cadbury Report (UK, 1992), the principles of Corporate
Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002). The Cadbury
and OECD reports present general principles around which businesses are expected to operate to
assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is
an attempt by the federal government in the United States to legislate several of the principles
recommended in the Cadbury and OECD reports. The main areas of the OECD principles are
thus as follows:

a) Ensuring the basis for an effective corporate governance framework: the corporate
governance framework should promote transparent and efficient markets, be consistent
with the rule of law and clearly articulate the division of responsibilities among different
supervisory, regulatory and enforcement authorities.
b) The rights of shareholders and key ownership functions: the corporate governance
framework should protect and facilitate the exercise of shareholders’ rights.
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c) The equitable treatment of shareholders: the corporate governance framework should

ensure the equitable treatment of all shareholders, including minority and foreign
shareholders. All shareholders should have the opportunity to obtain effective redress for
violation of their rights.
d) The role of shareholders in corporate governance: the corporate governance
framework should recognize the rights of stakeholders established by law or through
mutual agreements and encourage active co-operation between corporations and
stakeholders in creating wealth, jobs, and the sustainability of financially sound
enterprises.
e) Disclosure and transparency: the corporate governance framework should ensure that
timely and accurate disclosure is made on all material matters regarding the corporation,
including the financial situation, performance, ownership, and governance of the
company.
f) The responsibilities of the board: the corporate governance framework should ensure
the strategic guidance of the company, the effective monitoring of management by the
board, and the board’s accountability to the company and the shareholders.

All those principles can be summarized into key principles which are: responsibility,
accountability, fairness and transparency (Jesover and Kirkpatrick, 2005) and can be linked to
stakeholders’ satisfaction as shown in the figure below:

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Figure 2 : The link between good corporate governance practices and stakeholder’s
satisfaction

Responsibility

Accountability

Governance Stakeholder’s
principles satisfaction
Transparent

Fairness

Source: Edward (2014)

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CHAPTER FOUR:

International comparism of corporate governance practices

The study of corporate governance in different countries permits us to establish a distinction
between the practices in the Anglo-Saxon countries where the financial market plays a very
important role and those of the European continent and Japan where the intermediary system
dominates. We distinguish globally, many systems of governance in different countries or groups
of countries characterized by market forces, local culture or the influence of powers of the
various stakeholders. We will as such present successively, the Anglo Saxon system, the German
system, the Japanese system the French system and the African system.

4.1. The Anglo-Saxon model:

This model generally takes into consideration: The United States of America, Canada, and Great
Britain. It is a system characterized by a high institutionalization of the shareholder’s powers and
a very influential control of the market. The board of directors under this system cumulates both
the controlling and directing role. According to the Derek Higgs report in England, there is the
institution of the “institute of senior auditors”. This category of administrators comes in to
modify the functioning of the board of directors by playing an intermediary role between
shareholders and managers

These Anglo-Saxon countries have the particularity of haven favored the emergence and growth
of the financial market. As such, according to Frank and Mayer (1994), these countries are
characterized by a large number of home enterprises listed in the stock exchange market where
ownership rights and control mechanisms frequently change. Also, these countries have strict
rules of operation in the banking sector especially when it comes to acquiring shares in non
banking institutions.

The ownership structure is dispersed, Alvaro (2002), Abdelwahed (2003). The board of directors
is usually a size of between 12-13members.

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4.2. The German model or the network model

In the German system, the enterprise is considered as a combination of contracts. The

governance system thus lays emphasis on all the active parties within the enterprise. This system
is dualist in nature made up of a directorate which assures the direction function and the
supervisory board in charge of control. The most influential stakeholders here are the employees,
shareholders and the bank (schilling 2001, Alvaro 2002, Abdelwahed 2003).

The size of the supervisory board is usually large, composed of 20 members elected on a simple
majority vote by shareholders and workers (schilling 2001). The ownership structure is relatively
concentrated (Pablo, Azofra and Lopez, 2005). The individual responsibilities of the members of
the directorate and the supervisory boards are being reinforced progressively. Many authors
including Charreaux (1997) are indicating similarities between the German system and the
Japanese system

4.3. The Japanese system

Contrary to the German system, the Japanese system is characterized by its system of national
unity, influenced by its cultural attributes (Abdelwahed 2003). The family role, the avoidance of
conflict and the spirit of consensus play a significant role in governance under this system
(IMCG, 1995). This system could be considered as an intermediary between the Anglo-Saxon
system and the German system.

Actually, the governance organ is the board of directors made up of the board of administrators
and board of auditors. Each of these organs has a well specified responsibility. As in the German
system, power is concentrated in the hands of the employees, shareholders and banks. The
ownership structure is more dispersed than the German system and more dispersed than the
Anglo-Saxon system.

4.4. The French system: The mix system

This is seen as a mixed system of governance, under this system, we can choose between the
individual system or the dual system. According to the ICMG (1995), 98% of French listed
enterprises opt for the individual system.

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Whatever the structure, control is mostly in the hands of the shareholders. Minority shareholders
turn to also be very influential. The ownership structure is relatively concentrated. The banks,
other companies and the family are the main shareholders (Alvaro 2002).

4.5. The African system

Talking about the governance of enterprises in Africa simply implies presenting the
recommendations of the OHADA uniform act instituted since 1998 on business laws in Africa.
The governance system is seen as follows:

 Governance through the board of directors if the number of shareholders is greater

than or equal to three (3).
 Governance by general administrators who cumulates the functions of
administrator and controller when the number of shareholders is less than or equal
to three (3).

Thus, enterprises with three shareholders will have to choose which of them to use. According to
Art. 416 of the OHADA uniform act, the board of directors must have atleast 3 members
including two (2) shareholders. This is to say that those with less than 2 shareholders cannot
constitute a board of directors.

The board of directors is made up of between 3 and 12 member. In the case of fusion, this
number could go up to 20.

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CHAPTER FIVE: COMPTEMPORARY ISSUES IN CORPORATE GOVERNANCE

CHAPTER SIX: CASE APPLICATIONS

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