Corporate Governance: Some Theory and Implications

An attempt is made to provide a theoretical framework for the corporate governance debate, and to derive some implications that may be useful as a guide to policy. First, the conditions under which corporate governance issues are relevant are reviewed. The analysis is then applied to the case of a public company. It is argued that corporate governance issues arise wherever contracts are incomplete and agency problems exist. Further, in many cases, a market economy can achieve efficient corporate governance by itself. Two policy implications can be drawn from the analysis. First, the case for statutory rules is weak and so the Cadbury (1992) approach of trying to educate and persuade companies to make changes in corporate governance is probably the best one. Second, the Cadbury recommendations should be seen in the context of corporate governance generally. At the same time that Cadbury is promoted, it is important to ensure that existing mechanism can operate freely to provide appropriate checks and balances on managerial behavior.