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Corporate Governance and Risk Management Theories Essay

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Updated: Nov 20th, 2020


By definition, economic relationships imply that at least two stakeholders are involved in an exchange, which suggests that a system of standards and regulations should be in place as the method of controlling the economic machine (Klettner, 2017; Okoye, 2015). Herein the importance of corporate governance (CG) as a phenomenon lies. The very concept of CG is fairly simple; it mainly renders the idea of establishing and exerting control over a particular organisation (OECD, 2015; Baker & Filbeck, 2015). However, due to the multiple aspects of running a company, different approaches toward CG exist.

A Risk Management (RM) strategy is the process aimed at locating, assessing, and mitigating risks (Yoe, 2016). Therefore, RM should be seen as an inseparable part of CG within the context of an organisation (Waring, 2016; Miller, 2017). To understand how CG and RM function in tandem, it is necessary to consider several key CG theories that allow viewing the process of RM from the perspective of different stakeholders and, thus explore how each of the theories defines its key stakeholders and what tools it uses to meet their needs.

Agency Theory

The concept of the Agency Theory (AT) is quite self-explanatory since it revolves around determining the relationships between the participants, or agents, of business relationships. According to the AG postulates, the principal is superior to the agent (Clarke, 2017). The latter, in turn, is expected to act on behalf of the former in order to encourage the corporate growth and increase the profits (Dana & Ramadani 2015). Thus, despite the rigid hierarchy, the relationships between an agent and a principal are largely symbiotic, agents striving to represent the interests of their principals in the best way possible since the outcome aligns with their concept of a profit (Xi, Kraus, Filser, & Kellermanns, 2015).

Pros and Cons

The theory provides a rather clear and self-evident explanation of why agents pursue the objectives that cause their principals to benefit extensively (Sarkar, Wingreen, & Cragg, 2017). However, the opponents of the theory often point to a very problematic aspect to the AT framework. Specifically, it is often mentioned that the very existence of a company hinges on the notion that the needs of agents and principals are at the very least intersecting (Dawson, Denford, Williams, Preston, & Desouza, 2016). Therefore, even in case of the slightest contradictions between the interests of agents and the goals of principals, their further cooperation becomes highly questionable.

Corporate Governance

In regard to CG, the AT allows addressing the conflicts that emerge between an agent and a principal in case of the misalignment of their interests. In the scenarios that involve the lack of similarities between the objectives that agents, which are typically represented by employees, and principals, or their organisations, pursue, the AT can be used (Shi, Connelly, & Hoskisson, 2017). As a result, one can manage risks faced by the specified stakeholders of business relationships more efficiently than they would otherwise (Tricker, 2015; Bosse & Phillips, 2016). The AT framework offers the tools for an extensive analysis of the conflict of interests within the economic setting.

Risk Management

Because of its focus on the relationships within an organisation, the AT can be utilised to address internal issues occurring in a firm. Viewing corporate interactions through the prism of self-interest, the AT helps to reduce the risk associated with the internal inconsistencies within the firm (Mafrolla, Matozza, & D’Amico, 2016). The AT principles are related to the traditional “limits to arbitrage” (Callen & Fang, 2015, p. 184) concept and emphasise the necessity to offer arbitrageurs time and credit in order to leverage prices respectively (Bromiley, McShane, Nair, & Rustambekov, 2015). Thus, the key financial processes will remain under the control of arbitrageurs, and companies will avoid significant losses.

Stakeholder Theory

Another framework for corporate relationships that has been in existence for quite long, the Stakeholder Theory (ST) deserves being considered as an important tool for managing business relationships and leveraging prices. Created by Freeman, the ST is rather basic in its assumption that mutual respect and reliance should be the default for the relationships between all participants in business (You, 2015). The theory discerns several key stakeholders, which include shareholders, buyers, staff members, suppliers, and the community within which a business operates (Magnier, 2017). Giving a voice to all stakeholders whose needs a company is expected to address is the primary goal of the ST.

Pros and Cons

The idea of incorporating ethical principles and moral standpoints into the philosophy of an organisation as the starting point for decision-making within it is an admittedly positive idea that needs support. By focusing on the needs of all people and entities involved, a company will build a strong reputation of a firm with a strong moral compass and thus establish a market presence (Bonnafous-Boucher & Rendtorff, 2016; Mallin, 2016). Therefore, the public loyalty rates are going to rise exponentially as long as a firm follows the ethical standards that it has built for itself.

However, the suggested approach also leaves certain questions open, such as the exact definition of stakeholders. Indeed, closer scrutiny of the ST will reveal that it does not provide a clear definition for the term “stakeholder,” thus leaving ti to organisations to decide what the specified concept embraces (Yan, 2017; Behne, 2017). Furthermore, the proposed framework of managing business relationships does not provide the exact solution to managing the needs of different stakeholders (Ayuso, Rodríguez, García-Castro, & Ariño, 2014). Therefore, the ST framework could require certain improvements as the tool for CG.

Corporate Governance

When viewed from the perspective of CG, ST can be seen as the platform for building the relationships within a company by integrating corporate values and enhancing the significance of the Corporate Social Responsibility (CSR) (Schwartz, 2017). ST allows placing the emphasis on the ethics and philosophy of an organisation due to one of the three components that it incorporates (Theodoulidis, Diaz, Crotto, & Rancati, 2017). These include the instrumental power, which connects human resource management (HRM) to business practice, descriptive accuracy, which defines corporate behaviours, and normative validity, which defines the purpose of a company’s existence (Harrison, Freeman, & Abreu, 2015; Wasieleski & Weber, 2017). Therefore, due to the focus on the social value of an organisation and the relationships between its stakeholders, the theory allows developing a hierarchy of organisational interactions in order to address the needs of all stakeholders involved in the economic exchange (Fernando & Lawrence, 2014). The theory sheds light on some of the most complex aspects of CG since it enables company leaders to connect ethics and economics (Freeman & Dmytriyev, 2017; Agbadua, 2017; Pigé, 2017). Therefore, ST should be seen as a powerful tool for managing CG-related issues.

Risk Management

Based on the hierarchy that Freeman developed for the ST, the ST suggests arranging the process of RM in the context of a firm by assigning each stakeholder with a set of guidelines and tasks. Each of the participants is given the amount of information that corresponds to their level of involvement in the corporate processes and their degree of awareness concerning organisational issues (Horner & Wilmshurst, 2016; Hoskisson, Gambeta, Green, & Li, 2018). Furthermore, the use of the ST in the RM context implies assigning a specific complexity level to each task to distinguish between routine RM processes and urgent concerns (Obicci, 2017; Muller, 2017; Mansell, 2015). The next stages of RM in accordance with the ST framework imply consultations with stakeholders, location of opportunities and threats, evaluate the available options, and prioritise them respectively (Mason & Simmons, 2014; Liu, Zhan, Zhu, & Pan, 2016; Rose, Flak, & Sæbø, 2018; Cahya, Nuruddin, & Ikhsan, 2017).

Stewardship Theory

The Stewardship Theory (StT) is often compared to the AT framework since both imply introducing a corporate hierarchy based on the relationships that its stakeholders have to the key corporate processes. However, unlike the AT, the StT pays greater attention to the needs of owners and shareholders as opposed to agents (Glinkowska & Kaczmarek, 2015). Specifically, the Board of Supervisors is given more power than the Board of Managers, with the latter being accountable to the former (Keay, 2015). Therefore, motivating subordinated to excel in their performance and deliver the expected results is deemed as the focus of the theory.

In its essence, StT is based on McGregor’s Theory Y, which argues that people are prone to seeking the simplest and the least painstaking solutions and, therefore, need to be motivated to deliver the performance of the expected quality (Kellermanns & Hoy, 2016). Herein lies the choice of strategies that the StT framework offers and that mostly provide a leader with the opportunities for motivating staff members and managers (Hafeez, 2015). Therefore, the framework should be seen as one of the methods for regulating corporate relationships.

Pros and Cons

Among the obvious advantages of the StT, one should mention the fact that it allows increasing the role of institutional investors in the corporate setting. Therefore, by applying the StT to the context of entrepreneurship, one is likely to attract the attention of investors and create the premises for long-time partnership. Thus, the StT approach raises the levels of awareness regarding the weight of the stewardship ecosystem within a corporate setting (Burghausen & Balmer, 2015). As a result, a company is expected to create a societal and economic value throughout its functioning in the target market (Domínguez-Escrig, Mallén-Broch, Lapiedra-Alcamí, & Chiva-Gómez, 2018). Therefore, the StT approach toward analyzing corporate processes and improving them can be seen as rather valid.

The flaws of the StT are quite evident since the framework suggests taking the idea of corporate leadership to its extreme and dismisses the voices of any stakeholders other than the shareholders of an organisation. Ideally, the proposed approach toward managing an organisation could work in the scenario in which shareholders executed an ethically impeccable policy and were concerned with the needs of others as well as with the goal of increasing profit margins (Zhang, Wei, Yang, & Zhu, 2018). However, due to the understandable competitiveness in the realm of the global economy, the opportunities for ethically flawless leadership and the ability to embrace the needs of every stakeholder involved are miniscule (Effelsberg, Solga, & Gurt, 2014). Therefore, the specified theoretical approach needs to be supported with a tool that can increase the significance of ethical choices in the corporate setting.

Corporate Governance

In the context of CG, the StT grants the shareholders of an organisation the vast power to exert control over staff members. Particularly, the Supervisory Board, which executes control over the Management Board, is entitled to a vast number of roles and responsibilities (Subramanian, 2018; Song, Van Hoof, & Park, 2017). These include consultations, supervision, decision-making, the ability to coordinate the actions of all participants involved, and the management of information (Panaccio, Henderson, Liden, Wayne, & Cao, 2015). Therefore, the Supervisory Board is provided with the unlimited power over the crucial corporate processes since it controls the data that flows in the system of an organisation (Kruitwagen, Madani, Caldecott, & Workman, 2017). Based on the key tenets of the theory, with the appropriate leadership strategy applied, managers will make decisions on behalf of shareholders and, thus represent the organisation and support its needs.

Risk Management

As the background for the development of an RM approach, the StT tool can be seen as possible, if only somewhat flawed. In principle, the StT framework provides a rather decent platform for creating an efficient RM strategy since it is inherently rooted in encouraging staff members to act in the best interests of an organisation (Hiebl, 2015). However, due to the reliance on the loyalty of staff members, the StT may provide insufficient resources for a comprehensive RM strategy.

Transaction Cost Theory

Another theoretical approach that needs closer consideration as the possible platform for RM and CG, the Transaction Cost Theory (TCT) has been one of the dominant approaches toward managing business and economic relationships recently. The TCT suggests that outsourcing of resources and materials should be seen as the primary tool for enhancing corporate performance (Mroczek-Dąbrowska, 2014; Weber & Mayer, 2014). Therefore, based on the TCT framework, a company should consider viewing production as the decision that is superior to purchasing (Memili, Misra, Chrisman, & Welsh, 2017).

Pros and Cons

The TCT approach makes the process of allocating corporate resources easier. However, it also places significant restrictions on the opportunities that organisations can pursue in the contemporary global market (Ketokivi & Mahoney, 2016; Hitt, Xu, & Carnes, 2016). Outsourcing offers extensive opportunities for long-term saving, which means that the theory might not be easily applicable to the context of the present-day market realities.

Corporate Governance

In relation to the CG, the TCT approach suggests that the leaders of an organisation are not necessarily the primary owners thereof; instead, organisations should be seen as a part of something greater (Cruz, Haugan, & Rincon, 2014). Therefore, the TCT approach allows the CG process to veer into the areas of environmentalism, thus leading to a broader analysis of the effects that a firm has on the global society (Christensen, Nikolaev, & Moerman, 2016). Consequently, the TCT framework can be considered an important addition to the management of a firm in the realm of the global economy.

Risk Management

Similarly, due to its broad range, the TCT strategy embraces a wide array of problems regarding external risks. Specifically, the TCT views the business, its employees, customers, and suppliers as the key stakeholders whose needs a firm should value (Wu, Chen, Chen, & Cheng, 2014). However, the TCT also suggests that a company should consider its impact on a global scale, thus creating the framework for managing the risks associated with disasters and similar concerns.

Resource Dependency Theory

As its name suggests, the resource dependency theory focuses on the assets that a company owns. The Resource Dependency Theory (RDT) posits that the organisational behaviour within a company depends on the strategies that it uses for acquiring resources (Yeager, Zhang, & Diana, 2015). The RDT provides extensive opportunities for restructuring the bargaining position that a firm uses when participating in various transactions.

Pros and Cons

Among the benefits that the RDT brings, one should mention the possibility for independence in the choice of suppliers. With the specified change, one can locate clear rationales for decisions associated with finances and particularly investments, which is critical for any company operating in the global market (Bhatt & Bhattacharya, 2015). However, the RDT approach also implies that an organisation does not have reliable partners (Cooper, 2017). The specified problem affects a firm that uses the RDT approach significantly, causing difficulties in managing production, transportation, and distribution processes (Borkowski, 2015).

Corporate Governance

In the context of the CG framework, the RDT works as the means of reducing conflicts in the relationships between the key stakeholders (Gabrielsson, 2017). As a result, the RDT approach helps to integrate a multidisciplinary approach into the corporate decision-making process (Johnson & Rossow, 2017). Therefore, am RDT-based system allows for a reconciliation between the interests of the participants of economic relationships.

Risk Management

From the RM perspective, the use of the RDT approach can be seen as the method of reducing internal contradictions. With a drop in the levels of hostility within a company and with all participants being assured that their requirements are met, corporate growth can be facilitated (Austin & Jones, 2015). Therefore, the RDT can be deemed as an important device in handling intrinsic corporate dilemmas.


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