1.3 Agency theory, stakeholder’s theory and corporate governance

Agency Theory:

Agency theory is a conceptual framework that examines the relationship between principals (shareholders or owners) and agents (managers or executives) in an organization. It focuses on the potential conflicts of interest that may arise when the goals and objectives of the principals differ from those of the agents who are entrusted to act on their behalf.

In the context of financial management, agency theory highlights the principal-agent relationship between shareholders and managers. It recognizes that managers may have their own objectives and may not always act in the best interest of shareholders. The theory suggests that mechanisms such as performance-based incentives, monitoring systems, and clear contractual agreements can align the interests of shareholders and managers and mitigate agency problems.

Stakeholder Theory:

Stakeholder theory emphasizes the broader perspective of corporate governance by recognizing that corporations have responsibilities towards multiple stakeholders, including shareholders, employees, customers, suppliers, communities, and the environment. It argues that a firm’s long-term success is dependent on the positive relationships and cooperation among all stakeholders.

Financial management, within the context of stakeholder theory, involves considering the interests and well-being of all stakeholders, not just shareholders. It acknowledges that financial decisions should be made in a way that creates value for all stakeholders and considers the social and environmental impact of business activities.

Corporate Governance:

Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It encompasses the relationships among various stakeholders and provides a framework for decision-making, accountability, and oversight within an organization.

Financial management is closely tied to corporate governance as it involves making financial decisions and managing resources in accordance with the governance framework. Effective corporate governance ensures transparency, accountability, and responsible decision-making, safeguarding the interests of shareholders and stakeholders.

Financial managers play a vital role in corporate governance by providing accurate financial information, adhering to regulatory requirements, and implementing sound internal control systems. They contribute to the governance structure by aligning financial strategies with the organization’s objectives, ensuring appropriate risk management practices, and promoting ethical conduct in financial decision-making.

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