2.3.1 Theories influencing corporate governance

The rise of the firm, the economical and judicial theories, problems and remedies regarding the firm are described above. They all are closely connected to each other and to the topic below: corporate governance, being the frame (IV in figure 2.1a) that holds the scales in figure 2.1a, representing the theoretical framework of this study and explained further below. This framework is 'founded on' several economical theories partly clarifying its existence (V in figure 2.1a). The development of corporate governance is mainly explainable by four specific theories: the agency theory described above (Jensen and Meckling 1976), the transaction cost economics (Williamson 1981), the stewardship theory and the stakeholder theory (Mallin 2010, p. 19) (figure 2.3.1).1 Each theory throws light on some aspect(s) of corporate governance, but is limited to this/these aspect(s) alone and therefore cannot capture the theoretical basis of corporate governance as a whole (Clarke 2004, p. ix). The over time advanced understanding of the contents and relevance of the theories is taken into account in this respect. Moreover, legal systems, culture, ownership structures and the layout of the capital markets also cohere with corporate governance and the four theories. This section explains what these four theories imply, after which the concept of corporate governance and its evolution are explained.

The agency theory is described in section 2.2.4 above; therefore this section only contains some brief remarks. As a result of the separation of ownership and control, managers (the agents) had to manage and increase the invested money of the large group of dispersed shareholders (the principals). Because of the divergence in interests between the agents and principals agency problems occurred; managers acted to benefit their own interests and not the interests of their principals. If one agrees with the line of reasoning of scholars such as Jensen, Meckling, Berle and Means, the corporate scandals concerning large quoted international firms can be clarified by the separation of ownership and control and the attached agency problems. Nevertheless, La Porta, Lopez-de-Silanes et al. and Shleifer question the importance of the separation of ownership and control between managers and shareholders in relation to the agency theory. Based on their empirical research they state that: "large firms have a problem of separation and control, but not the one described by Berle and Means. These firms are not run by professional managers without equity ownership who are unaccountable to shareholders, but by controlling shareholders. These controlling shareholders are ideally placed to monitor the management" (La Porta, Lopez-de-Silanes et al. 1999, p. 511).

They find that in fact relatively low ownership dispersion exists around the world. Low ownership dispersion implies agency problems between minority and controlling shareholders to a larger extent than the agency problems between managers and shareholders. Apart from the discussion about which agency relationship prevails, the agency theory was indeed of great importance to the development of corporate governance. All three types of agency relationships (see section 2.2.6) and subsequently possible agency problems make an adequate corporate governance system within a firm - to be realised by the legal and economical remedies discussed above - a valuable and necessary asset. Over time the agency theory has been extended in parts, mainly by one of its founders, Michael Jensen. As discussed in section 2.2.4 Jensen acknowledged that the homo economicus behaves not only rationally but non-rationally as well, which can result in agency costs due to self-control problems (Jensen 1994, p. 7). Later on he adds that there is far too much focus on the conflicts of interests between people, between agents and principals. The damage caused by an individual's conflict of interests with himself needs more attention, i.e. these self-control problems or integrity problems. Jensen, Erhard and Zaffron argue that a large amount of damage inflicted on people and organisations is caused by actions of individuals that are not in their own self-interest and thus impose agency costs on those they are involved with (e.g. family, employers, associates and the public) (Erhard, Jensen et al. 2009) (Erhard, Jensen et al. 2010). They present a model of integrity that is assumed to result in increased performance of individuals, groups and society. Integrity is regarded as an objective state or condition of a person, group or organisational entity and defined as the person's word being whole and complete (i.e. honouring your word).2 Honouring your word is claimed to be the route to creating whole and complete social and working relationships resulting in unambiguous and actionable access to the opportunity for superior performance and competitive advantage at the individual, organisational and social levels (Erhard, Jensen et al. 2010).

According to the ' classical' agency theory, the shareholders' interests should be maximised and the managerial opportunism controlled to prevent agency problems. Donaldson and Davis believe in a contrasting approach: the stewardship theory (Donaldson and Davis 1991, p. 62). Economic theories assume that man is a homo economicus: that is being individualistic, opportunistic and self-serving. Jensen himself (see section 2.2.4 and above) criticised the belief in the homo economicus by pointing out the non-rational behaviour of men. Davis, Schoorman and Donaldson criticise the homo economicus as well and believe in a more social and psychological approach of the human being. Collectivism and trustworthiness are characteristics of man as well. The stewardship theory has a more positive view of man than the agency theory does: "the model of man is based on a steward whose behaviour is ordered such that pro-organizational, collectivistic behaviors have higher utility than individualistic, self-serving behaviors" (Davis, Schoorman et al. 1997, p. 24).

The adherents of this theory do not believe in controlling the managerial opportunism, for example by having a board chairman independent of the CEO or by using incentives to bind CEO interests to those of shareholders. According to the stewardship theory the steward (the agent) acts rationally (as a homo economicus) and aims for more efficiency. However, satisfying the organisation and the collective is his highest goal. Supporters ofthe stewardship theory trust the stewards to behave in the best interests of the company and therefore less supervision (i.e. another corporate governance system) is necessary than is believed by supporters of the agency theory. Nevertheless, it is questionable whether such a corporate governance system solely based on trust and with little supervision is sufficient nowadays to prevent more corporate scandals and to promote entrepreneurship that takes the interests of all the stakeholders into account. A corporate governance system that takes all the agency problems into account and above that acknowledges and rewards possible collectivism and trustworthiness of managers is most appropriate nowadays to prevent agency problems and corporate scandals.

The transaction costs economics considers the firm as a governance structure with internally undertaken transactions (Williamson 1984, p. 1201). The firm is a system of relationships that comes into existence because markets are not costless in use and as much certainty as possible is desired. If possible, contracts are brought into the firm to avoid costs and to provide more security. Although for purposes of security as much as possible is laid down in writing in these contracts, they remain incomplete due to the transaction costs. According to Williamson three kinds of transaction costs exist: (i) costs of considering all eventualities that can occur during the course of the contractual relationship, (ii) costs of negotiation with others about these plans, and (iii) writing down the agreements in such a way that they can be enforced by a third party (e.g. a judge) in the event of a dispute (Hart 1995, p. 680). Hart states that as a result of those high transaction costs the contracting parties will not write a comprehensive, but an incomplete contract. Because of the existence of incomplete contracts between principals and agents within and outside the firm, the governance structure of a firm should work as a mechanism for making the decisions that have not been specified in the contracts themselves (Hart 1995, p. 679) (Zingales 1997, p. 7). On the other hand, Hart's reasoning can be questioned. In situations that really do matter the parties involved probably are prepared to bear the high costs for a complete contract to gain total certainty. However, it is questionable whether complete contracts do exist. Is it possible that a contract contains all possible eventualities and the exact correct meaning of the contracting parties involved? Pacces defines the contractual incompleteness as: "non-contractibility ofall possible variables that affect the production of the exchange surplus - the so-called 'gains from trade', which are supposed to be captured by entering into a contract" (Pacces 2007, p. 158).

So although parties sometimes are prepared to bear the costs for a complete contract, the corporate governance structure remains a necessary mechanism for arranging the decisions that nevertheless have not been laid down in the contract.

The fourth theory to be described is the stakeholder theory. The stakeholder theory can be regarded as the opposite or extension of the shareholder theory. The shareholder theory purely takes the interests of the shareholders into account and is thus solely concerned with the shareholders' value. The stakeholder theory also takes the interests of other stakeholders (such as employers, customers, the government and the environment) into account (Freeman 1999). Traditionally the Anglo-Saxon countries (such as the UK and US) have a shareholder-orientated corporate governance system and the Rhineland countries a stakeholder-orientated system. Obviously the outlines of the systems vary from country to country, jurisdiction to jurisdiction and time period to time period. Intermediate forms exist as well, and are advocated by some scholars. For instance, Jensen argues for enlightened value maximisation or the enlightened shareholder theory that: "utilizes much ofthe structure of stakeholder theory but accepts maximization ofthe long run value ofthe firm as the criterion for making the requisite tradeoffs among its stakeholders" (Jensen 2001, p. 9).

Still subject to discussion is who the stakeholders of the firm are exactly. According to Blair, to be defined as a stakeholder you must have firm-specific assets that are at risk in the enterprise. Freeman states that this must be seen in a broader sense. In current times environment and society can be considered stakeholders as well, although they have no firm-specific assets at risk in the enterprise. The distinction made by Clarke between contractual stakeholders and community stakeholders marks this difference as well (Clarke 2004, p. 194). In reality, systems with characteristics of both the stakeholder and shareholder theory exist and who can be considered a stakeholder is subject to discussion. Nevertheless, shareholders and stakeholders favour different governance structures in a company (Mallin 2010, p. 18). They all want influence in the policy of the firm and want monitoring instruments to make sure that the principals act in their best interests. This divergence in interests sometimes results in frictions and therefore a good corporate governance system within companies is desired.

Although all four theories presented above have influenced the development of corporate governance, their importance has varied over time and has been criticised as well. For instance, La Porta, Lopez-de-Silanez, Shleifer and Pacces argue that corporate governance is not just a relationship between principals and agents and consider the importance of the agency theory to be overestimated. Donaldson and Davis favour the stewardship theory above the agency theory. However, it can in short be stated about these four theories, in relation to corporate governance, that a corporate governance system should take all agency relationships and problems into account whilst acknowledging and rewarding possible collectivism and trustworthiness of its stewards,not neglecting the fact that an adequate corporate governance system also functions as a mechanism against incomplete contracts (transaction costs) between agents and principals (shareholders and stakeholders).

All four theories had and still have their influence on the development of corporate governance; however none of them captures the theoretical basis of corporate governance as a whole. Legal systems, culture, ownership structures and the lay-out of the capital markets are of importance as well to the development and lay-out of the corporate governance structure in a specific country or company. Certain trends in the four theories over time and per country/continent are visible. For example, the 'classical' agency theory has been extended and seems to lose battleground to the stewardship theory. Moreover, in Europe the stakeholder theory gained importance over the Anglo-Saxon shareholder theory. However, due to internationalisation and active shareholders, the shareholder theory seems to seep into the European corporate governance structure again. As the foundation of the scales representing the theoretical framework of this study (V in figure 2.1.a), the coherence of the theories underlying corporate governance has no fixed form. This variable coherence between the theories underlying the concept of corporate governance not only influences the concept itself but simultaneously the contents of national corporate governance codes and their application in practice as elaborated further below.