Corporate governance Essay Example | Topics and Well Written Essays - 1500 words

Corporate governance - Essay Example 12). This paper seeks to compare and contrast the theoretical framework of corporate governance, and explain how agency theory can be used to explain corporate governance arrangements in modern companies. The agency theory emanates from the separation of control from ownership such that professional managers manage the firm on behalf of the original owners. The theory draws strength in the rise of conflicts when the owner of a firm perceives that professional managers do not follow the best interests of the owners (Wong and Mwanzia, 2011, p., 2011, p. 16). The theory focuses on analyzing and resolving relationship between owners and shareholders of a firm and the agents or top management, this is based on the basic assumption that the role of a firm is to maximize the wealth and investment of its owners and shareholders. The agency theory works based on a form operating with limited information and uncertainty in its operations. As a result, the firm remains exposed to possibilities of agency issues such as adverse selection and moral hazard. Adverse selection in this case occurs when principals fail to determine, with certainty, whether an agent accurately portrays his or her ability to execute the duties with which they are charged. On the other hand, moral hazard refers to a condition under which a principal cannot ascertain the probability of an agent putting or giving their best towards the wellbeing of a firm (Wong and Mwanzia, 2011, p. 16). The theory also purports that availing superior information on a firm to professional managers gives an edge to agents over the owners. This is because the top managers of a firm may bear more interest in individual welfare than that of the firm or its shareholders and owners. This way, managers fail to act maximally towards the returns of a firm unless proper governance structures are out in place as a means to safeguard the interest of shareholders (Wong and Mwanzia, 2011, p. 16). As a result, the agency theory call s for curtailing the potential of managers to behave in ways that contradict the best interests of shareholders and owners of any given firm. In addition, the theory brings to light the strength of top management in having the stock of a firm held in a wide manner by many shareholders, and the composition of the board of directors being that of people with little knowledge on the firm. According to this theory, the management should be in a position to own stocks of the firm they manage in order to create a positive relationship between corporate governance and the amount of stock owned by the top management (Wong and Mwanzia, 2011, p. 16). This way, the agency managing the form can put the interests of the firm ahead of their own, and the conflict between ownership and agency can end. Thus, because of having a substantial amount of stock in their name, top management becomes more willing to take responsibility for the decisions it makes concerning the firm. In addition of concern, is the issue of generating rules and incentives