When within the firm may arise. Corporate governance mechanisms

Topic: BusinessComparative Analysis
Sample donated:
Last updated: July 27, 2019

When business activities expand immensely with timethe ownership of the firm is distributed among number of investors to collectrequired funds for the expansion. All these investors as the new owners of the companycannot involve in the monitoring and controlling activities due to many reasons.

Involving with managing activities is not possible to all the owners and ifthey involved it consumes time and ultimately it effects to the performance. Themuch more important and possible option is to appointing an effective board ofdirectors.There for they appoint a board of directors to evadethis inability and carry on managing and controlling activities moreeffectively rather than the owners resulting a separation of ownership from thefirm. Corporate governance is about how these board members monitor themanagers in the company and how they become accountable to shareholders inreturn. In brief corporate governance is a result of complex corporateorganizations and globalization.The terms “governance” and “management” are not thesame even they consider to be similar. Corporate management is preferred to thetypical procedure which involves in making decisions within the company. Thepool of rules and practices which ensure the extent that all the stakeholdersare served properly is defined as corporate governance.

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14Members of the board are acting on behalf of the allshareholders, the real owners. These principals to agent relationship raisesome issues when carrying out better governance on the company.Further 14 states that agency approach describes thecontractual interpretation of a firm related to the shareholders (Principals)and company’s directors (Agents). Agency theory is criticized when directors are actingfor self-interest than owners’ interest.

Therefor interests of the directorsneed to be line up towards the interests of owners and unless agency costs andinefficiencies within the firm may arise. Corporate governance mechanisms areused to ensure the behavior of directors aligned towards owners’ interest.According to 14 such corporate governance mechanisms are effective boardstructure, compensation contracts, active monitoring of executives and marketfor corporate control.According to 49, corporate governance is acountrywide system in a formal structure to gain advantages from corporateorganizations where agency costs are reduced in a stable fashion with thesociety’s history, legal, political and social traditions. Corporate behavioris built up by the link of economic incentives and disincentives created bycorporate governance system.When the board consist a considerable proportion ofowners, it can eliminate most of the agency problems. But observations have concludedthat large number of block holders cause to ineffective governance and increasethe influence on CEOs. 05Because of the conflicts arise in an agency,remuneration to directors is debatable.

As stated in 45, there are fourcorporate governance mechanisms and executive compensation is one of them.Further executive compensation is defined as a mechanism aligning the interestsof managers and shareholders. Even most of the studies have identified apositive relationship between executive pay and performance in US, Germany andJapan.

45After examining the firm performance and CEOcompensation components, there is a positive association between changes incompensation and changes in firm performance. Due to the changes in marketreturns, bonuses paid to the CEOs are changing as well. (04)CEO compensation largely depends on a firm’saccounting performance than on stock market performance.

It is proved when firmperformance is measured using ROA. And even the leading shareholders are havinga less impact on the compensation made to CEOs. 05However agency theory indicates that thecompensation to directors is positively correlated to corporate performance.Therefor firms tend to prepare more attractive compensation packages tomotivate directors providing expected incentives.

45According to 01, after studying the relationship ofpay and performance findings have revealed a significant pay and performancerelationship among sample firms. Further they have not identified payperformance relationship based on market based measures and argued that theexecutive compensation is determined depending on accounting based measuresrather than market based measures.In 02, have carried out their research to examinethe relationship of firm performance measures and cash compensation with newand old CEOs to investigate the relationship in two models. The results haveindicated that both accounting and market based performance measures arerelated to the cash compensation of new CEOs showing positive correlation.Conversely they have identified negative and insignificant relation betweenperformance measures and cash compensation of CEOs about to retire.In Sri Lankan context many corporate governancepractices are adopted by British practices which are established throughvoluntary codes giving freedom to companies to have their own preferences inexecuting. As Sri Lankan companies are having family or concentrated ownership,the corporate governance practices created for disseminated ownershipenvironment create disputes in the efficiency of governance systems in SriLanka.

14In Sri Lanka social, cultural and economicconditions are very much differ from western countries. In that case referringto the studies conducted in western context or applying the findings to SriLankan context is limited.One of the major characteristics of a firm isseparation of ownership and the control. In that case there must be a propercorporate governance system that meets the requirements of shareholders as wellas the firm. According to a survey steered by Association ofChartered Certified Accountants have find out an increasing awareness in theSouth East Asian countries on employing corporate governance systems for thesuccess.

14In this research it is expected to find out howdirectors compensation act as a corporate governance mechanism to achievedesired performance of the firm. And make recommendations on how to usecompensation contracts to attract and retain skillful directors in the company.

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