Is Corporate Governance an extension of Agency Theory? ~ Scope of Corporate Governance

Not entirely. Agency theory covers only the agent-principal relationship. According to this theory, when an agent is asked by a principal to look after something on behalf of the principal, and if a situation arises where the interests of the principal and agent clash, the agent is likely to look after his own interest rather than that of the principal. This is true in case of companies to the extent that directors (agents) are entrusted by the shareholders (principal) to look after the affairs of the company and directors are likely to look after their own interest first and that of the shareholders later. However, when we talk of corporate governance we do not talk of the interest of shareholders versus the interest of the management. The focus of governance is “interest of each stakeholder” and the “collective interest of all stakeholders” not just the interest of one particular party, namely the shareholders. While it is correct that managers are likely to take care of their own interest first, but in the case of a corporate entity, the directors are not managers - they are intended to be watchdogs over management. Hence, the agency theory does have some relevance to corporate governance but does not apply fully. The relationship is not two-sided but triangular: shareholders (principal), directors (watchdogs) and managers (agents). A collusion between directors and managers (as indeed has been happening in the West) is a different matter altogether. In that situation, both the directors and managers become agents and jointly subvert the interest of the shareholders (principal). And this may even extend to subverting the interest of all stakeholders.

The following chart lists the interests of different stakeholders attached to the company. It also shows the collective interest of all stakeholders. And finally it shows the tools and techniques that are available to the company to help achieve these objectives:

There are essentially three approaches to governing a company available to a Board of Directors, namely shareholders’ approach, stakeholders approach and enlightened shareholders approach.