Corporate governance stands for a system of internal laws, rules, and practices, which are used to control and govern the decisions made by the company’s employees and managers in the scope of day-to-day activity. Various forms of corporate governance existed long before the appearance of the definition and various theories, as well as before the development of management into an academic discipline. They are used to describe the relationships between shareholders, stakeholders, the government, the society, and other various internal and external forces surrounding a business organization. Due to the variety of factors influencing the company and the market, no single theory can be used to define and explain the phenomenon. The purpose of this paper is to compare and analyze two opposing theories of corporate governance, which are the Agency theory and the Stewardship theory.
Agency theory was proposed in 1972 by Alchian and Demsetz and further elaborated on in studies by Jensen and Meckling, four years later (Tricker 59). This theory is very extensive and covers various areas, such as accounting, marketing, economics, sociology, politics, corporate and organizational behaviors. This theory defines the relationship between different parties involved in corporate governance as a contract under which employees (or managers/directors) are obligated to perform services on behalf of company owners (principals) (Tricker 59). According to this theory, the principals elect their representatives and give them the responsibilities to act and protect their best interest in return for compensation.
Aligning the interests of owners and managers is one of the primary aspects of the agency theory. It operates on the assumption that the interests of principals and executives remain in the state of permanent conflict, which cannot be solved. In order to keep managers in line and prevent them from cheating out the shareholders, rigorous systems of control must be put in place (Madhani 11). All expenses associated with control are offset by the increase in quality and decrease in corporate theft.
Stewardship theory, in many ways, serves as an antithesis of Agency theory, as it emphasizes the ‘Theory Y’ of motivation (Madhani 14). This theory states that in a healthy corporate culture built on honesty, integrity, and trust, there needs not to be an emphasis on monitoring. This theory highlights the existence of healthy working relationships between managers and shareholders, which, in turn, helps minimize the costs of monitoring and controlling while increasing the speed of decision-making and the autonomy of managers and executives. According to the stewardship theory, managers and employees are trustworthy individuals, and as long as they are compensated according to their needs, there is little to no risk of them abusing their positions and causing harm to shareholders’ interests (Bosse and Phillips 277). Thus, stewardship theory advocates management empowerment and the active role of shareholders in their own companies.
The reason why Agency theory and Stewardship theory are so different lies in the initial assumptions behind them. Agency theory is based on the X theory of motivation, which assumes that the average worker or manager is lazy, has little interest in work, and works only to gain a sustainable income. Therefore, they require constant supervision and control in order to provide the bare minimum required by the organization. The Y theory of motivation, however, states that employees can be internally motivated to better themselves by utilizing non-material encouragement practices. Appreciation, status, and satisfaction from a job well done are what drives employees better than threats of punishment and intimidation.
When translated into the Agency theory, it becomes a justification for establishing monitoring mechanisms in order to eliminate the conflict of interest. The associated costs are dubbed “agency costs.” In addition, agency theory advocates for the use of outside forces to monitor the processes in a company, as outsiders are less likely to be involved in corruption. Stewardship theory, on the other hand, advocates for the appointment of executive directors from inside the company, stating that a manager that rose up through the corporate ladder is likely to know the company from the inside out and make decisions based on internal knowledge of the situation and personal experience.
Personal Reflections and Conclusions
Personally, I feel that the Stewardship theory is closer to my own set of values and beliefs than the agency system. It is because I view myself as an honest person that can be entrusted to do my duty without anyone looking over my shoulder. However, I recognize that both of these theories have some truth to them. Stewardship theory is more in line with modern leadership theories, such as transitional leadership or servant leadership, which are used to cultivate trust and personal growth in managers and employees alike.
At the same time, some of the recent scandals regarding corporate theft and managerial fraud in large companies, such as Microsoft, Google, Walmart, and others, show that the idea of control at the highest levels of performance is not an idea to be discarded (Keay 1293). It is possible to introduce agency-based mechanisms in a predominantly stewardship-based organization (Tilema 153). In China, Agency theory is very popular due to the repetitiveness of work, low pay, and poor conditions (Jinghan 26).
Controlling mechanisms are required, as without them the quality of products will inevitably fall. My conclusion mirrors the statement made at the beginning of the paper, that a single theory is not enough to describe the realities of corporate governance. Both theories have their strengths as well as weaknesses and should be used in accordance with the situation.
Bosse, Douglas A., and Robert A. Phillips. “Agency Theory and Bounded Self-Interest.” Academy of Management Review, vol. 42, no. 2, 2016, pp. 276-297.
Jinghan, Chen. A Primer on Corporate Governance: China. Business Expert Press, 2015.
Keay, Andrew. “Stewardship Theory: Is Board Accountability Necessary?” International Journal of Law and Management, vol. 59, no. 6, 2017, pp. 1292-1314.
Madhani, Pankaj M. “Diverse Roles of Corporate Board: A Review of Various Corporate Governance Theories.” IUP Journal of Corporate Governance, vol. 16, no. 2, 2017, pp. 7-28.
Tilema, Sandra. “Does an Agency-Type of Audit Model Fit a Stewardship Context? Evidence from Performance Auditing in Dutch Municipalities.” Financial Accountability and Management, vol. 32, no. 2, 2016, pp. 135-156.
Tricker, Bob. Corporate Governance: Principles, Policies, and Practices. 3rd ed., Oxford, 2015.