Now that we have a strong understanding of business entities and how they are formed, we need to look at the manner by which they are organized and operated.

What is Business Governance?

Business governance concerns the actions and controls placed on those charged with managing a business entity.

Business governance is the subject of extensive legislation and research, particularly as it pertains to the corporate entity form.

Corporate governance generally concerns the internal control of a corporation as influenced or controlled by state and federal law, rules of ethics, and industry standards. It specifically focuses on the actions of managers and directors and the observance of procedural safeguards of shareholder rights.

• Example: Issues in corporate governance include, voting rights, meeting requirements, approval of corporate actions, record retentions, disclosure of information, and any other procedural undertakings concerning the management of the corporation.

What is the stakeholder theory of corporate governance?

The stakeholder theory of corporate governance focuses on the effect of corporate activity on all identifiable stakeholders of the corporation.

This theory posits that corporate managers (officers and directors) should take into consideration the interests of each stakeholder in its governance process.

This includes taking efforts to reduce or mitigate the conflicts between stakeholder interests.

It looks further than the traditional members of the corporation (officers, directors, and shareholders) and also focuses on the interests of any third party that has some level of dependence upon the corporation.

Stakeholders are generally divided into internal and external stakeholders.

• Internal Stakeholders – Are the corporate directors and employees, who are actually involved in corporate governance process.
• External Stakeholders – May include creditors, auditors, customers, suppliers, government agencies, and the community at large.

These stakeholders exert influence but are not directly involved in the process.

Key to the stakeholder theory is the realization that all stakeholders engage in some manner with the corporation with the hope or expectation that the corporation will deliver the type of value desired or expected.

The benefits may include dividends, salary, bonuses, additional orders, new jobs, tax revenue, etc.

We discuss the intricacies of entity governance is far greater detail in other Courses.

What is Agency Theory?

Agency theory posits that corporations act as agents of its shareholders.

That is, shareholders invest in corporate ownership and thereby entrust their resources to the management of the directors and officers of the corporation, who serve as agents of the shareholders.

Agency Theory posits that corporations, as agents of shareholders, must take actions and pursue activities that promote the best interest of shareholders.

This is generally interpreted as corporations must prioritize making decisions and take actions that increase shareholder wealth.

How Do Individual Interests Affect Agency Theory?

In larger corporations, there is often a sharp divergence between the short and long-term interest of officers and shareholders.

This is primarily brought on by short-term demand for profits and the asymmetry of information that officers and directors possess compared with that of shareholders.

The divergence of interest between officer, director, and shareholder is thought to influence the actions and decisions of officers and directors who may become detached from shareholder interests.

This is inconsistent with the role of an agent.

How Does Agency Theory Affect Corporate Governance?

Corporate governance rules seek to establish a legal framework similar to that of the agent-principal relationship. These rules seek to:

• align the incentives of officers and directors with those of shareholders
• establish norms and customs that prevent the adverse results of divergent corporate interests;
• affect the duties that officers or director owe to the corporation.