STUDY MATERIAL

BUSINESS ETHICS AND CORPORATE GOVERNANCE

MODULE –II

MBA 4th Semester

GANDHI INSTITUTE FOR TECHNOLOGY,

BHUBANESWAR

Faculty Name:Mr Biswajit Pattajoshi

Department of MBA

GANDHI INSTITUTE FOR TECHNOLOGY

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MBC 401: ‐ BUSINESS ETHICS AND CORPORATE GOVERNANCE

Module –II Corporate Governance. Origin and Development of Corporate governance, Theories underlying Corporate Governance (Stake holder’s theory and Stewardship theory, Agency theory, Separation of ownership and control, corporate Governance Mechanism: Anglo‐American Model, German Model, Japanese Model, Indian Model, OECD, emphasis on Corporate governance, Ethics and Governance, Process and Corporate Governance (Transparency Accountability and Empowerment).

Corporate governance is "the system by which companies are directed and controlled" (Cadbury Committee, 1992). It involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders; it deals with prevention or mitigation of the conflict of interests of stakeholders. Ways of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have impact on the way a company is controlled. An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to decrease the principal–agent problem.

Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed.[5][6] In contemporary business corporations, the main external stakeholder groups are shareholders, debtholders, trade creditors, suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are the board of directors, executives, and other employees. It guarantees that an enterprise is directed and controlled in a responsible, professional, and transparent manner with the purpose of safeguarding its long-term success. It is intended to increase the confidence of shareholders and capital-market investors.

A related but separate thread of discussions focuses on the impact of a corporate governance system on economic efficiency, with a strong emphasis on shareholders' welfare; this aspect is particularly present in contemporary public debates and developments in regulatory policy (see regulation and policy regulation).

There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large corporations, most of which involved accounting fraud. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include Enron Corporation and MCI Inc. (formerly WorldCom). Their demise is associated with the U.S. federal government passing the Sarbanes-Oxley Act in 2002, intending to restore public confidence in corporate governance. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP

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9 reforms. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy).

Principles of corporate governance

Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002). The Cadbury and OECD reports present general principals around which businesses are expected to operate to assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports.

Rights and equitable treatment of shareholders:[9][10][11] Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.

Interests of other stakeholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.

Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment

Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.

Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Corporate governance models around the world

There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded.

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The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated or multi-stakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community.

Continental Europe

Some continental European countries, including Germany and the Netherlands, require a two-tiered Board of Directors as a means of improving corporate governance. In the two-tiered board, the Executive Board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions.

India

India's SEBI Committee on Corporate Governance defines corporate governance as the "acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company." It has been suggested that the Indian approach is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution, but this conceptualization of corporate objectives is also prevalent in Anglo-American and most other jurisdictions.

The United States and the UK

The so-called "Anglo-American model" (also known as "the unitary system") emphasizes a single-tiered Board of Directors composed of a mixture of executives from the company and non-executive directors, all of whom are elected by shareholders. Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. The United States and the United Kingdom differ in one critical respect with regard to corporate governance: In the United Kingdom, the CEO generally does not also serve as Chairman of the Board, whereas in the US having the dual role is the norm, despite major misgivings regarding the impact on corporate governance.

In the United States, corporations are directly governed by state laws, while the exchange (offering and trading) of securities in corporations (including shares) is governed by federal legislation. Many U.S. states have adopted the Model Business Corporation Act, but the dominant state law for publicly-traded corporations is Delaware, which continues to be the place of incorporation for the majority of publicly-traded corporations.[25] Individual rules for corporations are

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based upon the corporate charter and, less authoritatively, the corporate bylaws.[25] Shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws.

Regulation

Legal environment - General

Corporations are created as legal persons by the laws and regulations of a particular jurisdiction. These may vary in many respects between countries, but a corporation's legal person status is fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold property in its own right without reference to any particular real person. It also results in the perpetual existence that characterizes the modern corporation. The statutory granting of corporate existence may arise from general purpose legislation (which is the general case) or from a statute to create a specific corporation, which was the only method prior to the 19th century.

In addition to the statutory laws of the relevant jurisdiction, corporations are subject to common law in some countries, and various laws and regulations affecting business practices. In most jurisdictions, corporations also have a constitution that provides individual rules that govern the corporation and authorize or constrain its decision-makers. This constitution is identified by a variety of terms; in English-speaking jurisdictions, it is usually known as the Corporate Charter or the [Memorandum and] Articles of Association. The capacity of shareholders to modify the constitution of their corporation can vary substantially.

Codes and guidelines

Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect. For example, companies quoted on the London, Toronto and Australian Stock Exchanges formally need not follow the recommendations of their respective codes. However, they must disclose whether they follow the recommendations in those documents and, where not, they should provide explanations concerning divergent practices. Such disclosure requirements exert a significant pressure on listed companies for compliance.

One of the most influential guidelines has been the 1999 OECD Principles of Corporate Governance. This was revised in 2004. The OECD guidelines are often referenced by countries developing local codes or guidelines. Building on

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the work of the OECD, other international organizations, private sector associations and more than 20 national corporate governance codes, the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) has produced their Guidance on Good Practices in Corporate Governance Disclosure. This internationally agreed[26] benchmark consists of more than fifty distinct disclosure items across five broad categories:

Auditing Board and management structure and process Corporate responsibility and compliance Financial transparency and information disclosure Ownership structure and exercise of control rights

The investor-led organisation International Corporate Governance Network (ICGN) was set up by individuals centered around the ten largest pension funds in the world 1995. The aim is to promote global corporate governance standards. The network is led by investors that manage 18 trillion dollars and members are located in fifty different countries. ICGN has developed a suite of global guidelines ranging from shareholder rights to business ethics. The World Business Council for Sustainable Development (WBCSD) has done work on corporate governance, particularly on accountability and reporting, and in 2004 released Issue Management Tool: Strategic challenges for business in the use of corporate responsibility codes, standards, and frameworks. This document offers general information and a perspective from a business association/think-tank on a few key codes, standards and frameworks relevant to the sustainability agenda.

In 2009, the International Finance Corporation and the UN Global Compact released a report, Corporate Governance - the Foundation for Corporate Citizenship and Sustainable Business, linking the environmental, social and governance responsibilities of a company to its financial performance and long-term sustainability.

Most codes are largely voluntary. An issue raised in the U.S. since the 2005 Disney decision[28] is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors, corporate managers and individual companies tend to be wholly voluntary but such documents may have a wider effect by prompting other companies to adopt similar practices.

History - United States

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In 19th century United States, state corporation laws enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. Since that time, and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law, and because the US's wealth has been increasingly securitized into various corporate entities and institutions, the rights of individual owners and shareholders have become increasingly derivative and dissipated.

In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the modern corporation in society. Berle and Means' monograph "The Modern Corporation and Private Property" (1932, Macmillan) continues to have a profound influence on the conception of corporate governance in scholarly debates today. From the Chicago school of economics, Ronald Coase's "The Nature of the Firm" (1937) introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave. Fifty years later, Eugene Fama and Michael Jensen's "The Separation of Ownership and Control" (1983, Journal of Law and Economics) firmly established agency theory as a way of understanding corporate governance: the firm is seen as a series of contracts. Agency theory's dominance was highlighted in a 1989 article by Kathleen Eisenhardt ("Agency theory: an assessment and review", Academy of Management Review).

US expansion after World War II through the emergence of multinational corporations saw the establishment of the managerial class. Accordingly, the following Harvard Business School management professors published influential monographs studying their prominence: Myles Mace (entrepreneurship), Alfred D. Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). According to Lorsch and MacIver "many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors."

Over the past three decades, corporate directors’ duties in the U.S. have expanded beyond their traditional legal responsibility of duty of loyalty to the corporation and its shareholders.[29]

In the first half of the 1990s, the issue of corporate governance in the U.S. received considerable press attention due to the wave of CEO dismissals (e.g.: IBM, Kodak, Honeywell) by their boards. The California Public Employees' Retirement System (CalPERS) led a wave of institutional shareholder activism (something only very rarely seen before), as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (e.g., by the unrestrained issuance of stock options, not infrequently back dated).

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In 1997, the East Asian Financial Crisis severely affected the economies of Thailand, Indonesia, South Korea, Malaysia, and the Philippines through the exit of foreign capital after property assets collapsed. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies.

In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron and Worldcom, as well as lesser corporate scandals, such as Adelphia Communications, AOL, Arthur Andersen, Global Crossing, Tyco, led to increased political interest in corporate governance. This is reflected in the passage of the Sarbanes-Oxley Act of 2002.

Parties to corporate governance

The most influential parties involved in corporate governance include government agencies and authorities, stock exchanges, management (including the board of directors and its chair, the Chief Executive Officer or the equivalent, other executives and line management, shareholders and auditors). Other influential stakeholders may include lenders, suppliers, employees, creditors, customers and the community at large.

The agency view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders. Agency concerns (risk) are necessarily lower for a controlling shareholder.

A board of directors is expected to play a key role in corporate governance. The board has the responsibility of endorsing the organization's strategy, developing directional policy, appointing, supervising and remunerating senior executives, and ensuring accountability of the organization to its investors and authorities.

All parties to corporate governance have an interest, whether direct or indirect, in the financial performance of the corporation. Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments, while returns to equity investors arise from dividend distributions or capital gains on their stock. Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned with corporate social performance.

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A key factor in a party's decision to participate in or engage with a corporation is their confidence that the corporation will deliver the party's expected outcomes. When categories of parties (stakeholders) do not have sufficient confidence that a corporation is being controlled and directed in a manner consistent with their desired outcomes, they are less likely to engage with the corporation. When this becomes an endemic system feature, the loss of confidence and participation in markets may affect many other stakeholders, and increases the likelihood of political action. There is substantial interest in how external systems and institutions, including markets, influence corporate governance.

Control and ownership structures

Control and ownership structure refers to the types and composition of shareholders in a corporation. In some countries such as most of Continental Europe, ownership is not necessarily equivalent to control due to the existence of e.g. dual-class shares, ownership pyramids, voting coalitions, proxy votes and clauses in the articles of association that confer additional voting rights to long-term shareholders.[30] Ownership is typically defined as the ownership of cash flow rights whereas control refers to ownership of control or voting rights.[31] Researchers often "measure" control and ownership structures by using some observable measures of control and ownership concentration or the extent of inside control and ownership. Some features or types of control and ownership structure involving corporate groups include pyramids, cross-shareholdings, rings, and webs. German "concerns" (Konzern) are legally recognized corporate groups with complex structures. Japanese keiretsu (系列) and South Korean chaebol (which tend to be family-controlled) are corporate groups which consist of complex interlocking business relationships and shareholdings. Cross-shareholding are an essential feature of keiretsu and chaebol groups [4]. Corporate engagement with shareholders and other stakeholders can differ substantially across different control and ownership structures.

Family control

In many jurisdictions, family interests dominate ownership and control structures. It is sometimes suggested that corporations controlled by family interests are subject to superior oversight compared to corporations "controlled" by institutional investors (or with such diverse share ownership that they are controlled by management). A recent study by Credit Suisse found that companies in which "founding families retain a stake of more than 10% of the company's capital enjoyed a superior performance over their respective sectorial peers." Since 1996, this superior performance amounts to 8% per year.[32] Forget the celebrity CEO. "Look beyond Six Sigma and the latest technology fad. A study by Business Week[33] claims that "BW identified five key ingredients that contribute to superior performance. Not all are qualities are unique to enterprises with retained family interests."

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The significance of institutional investors varies substantially across countries. In developed Anglo-American countries (Australia, Canada, New Zealand, U.K., U.S.), institutional investors dominate the market for stocks in larger corporations. While the majority of the shares in the Japanese market are held by financial companies and industrial corporations, these are not institutional investors if their holdings are largely with-on group.

The largest pools of invested money (such as the mutual fund 'Vanguard 500', or the largest investment management firm for corporations, State Street Corp.) are designed to maximize the benefits of diversified investment by investing in a very large number of different corporations with sufficient liquidity. The idea is this strategy will largely eliminate individual firm financial or other risk and. A consequence of this approach is that these investors have relatively little interest in the governance of a particular corporation. It is often assumed that, if institutional investors pressing for will likely be costly because of "golden handshakes") or the effort required, they will simply sell out their interest.

Mechanisms and controls

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. For example, to monitor managers' behavior, an independent third party (the external auditor) attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability.

Internal corporate governance controls

Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance.[34] Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria.

Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable

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assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting

Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met.

Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior.

Monitoring by large shareholders and/or monitoring by banks and other large creditors: Given their large investment in the firm, these stakeholders have the incentives, combined with the right degree of control and power, to monitor the management.[35]

In publicly-traded U.S. corporations, boards of directors are largely chosen by the President/CEO and the President/CEO often takes the Chair of the Board position for his/herself (which makes it much more difficult for the institutional owners to "fire" him/her). The practice of the CEO also being the Chair of the Board is known as "duality". While this practice is common in the U.S., it is relatively rare elsewhere. In the U.K., successive codes of best practice have recommended against duality.

External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include:

competition debt covenants demand for and assessment of performance information (especially

financial statements) government regulations managerial labour market media pressure takeovers

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Financial reporting and the independent auditor

The board of directors has primary responsibility for the corporation's external financial reporting functions. The Chief Executive Officer and Chief Financial Officer are crucial participants and boards usually have a high degree of reliance on them for the integrity and supply of accounting information. They oversee the internal accounting systems, and are dependent on the corporation'saccountants and internal auditors.

Current accounting rules under International Accounting Standards and U.S. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance (see creative accounting and earnings management) increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce these risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independent external auditor who issues a report that accompanies the financial statements (see financial audit). It is

One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-Oxley Act (following numerous corporate scandals, culminating with the Enron scandal) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of Standard Listing Agreement in India.

Systemic problems of corporate governance

Demand for information: In order to influence the directors, the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting.

Monitoring costs: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors.

Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the

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financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process.

Executive remuneration/compensation

Research on the relationship between firm performance and executive compensation does not identify consistent and significant relationships between executives' remuneration and firm performance. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others.

Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.

Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal.

Even before the negative influence on public opinion caused by the 2006 backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including U.S. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for U.S. Standard & Poors 500 companies surged to a $500 billion annual rate in late 2006 because of the impact of options. A compendium of academic works on the option/buyback issue is included in the study Scandal by author M. Gumport issued in 2006.

A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing a share repurchase plan.

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Fundamental and Ethics Theories of Corporate GovernanceHistory has revealed that there is a never-ending evolution of theories or models of corporate governance. One of the reasons is due to the very essence of social consciences that is minimal and profit making took center stage. All over the world, companies are trying to instill the sense of governance into their corporate structure. With the surge of capitalism, corporation became stronger while governments all over the world had to succumb to its manipulations and dominance. Hence, this article is a review of literature onthe range of theories in corporate governance. The fundamental theories in corporate governance began with the agency theory, expanded into stewardship theory and stakeholder theory and evolved to resource dependency theory, transaction cost theory, political theory and ethics related theories such as business ethics theory, virtue ethics theory, feminists ethics theory, discourse theory and postmodernism ethics theory. However, these theories address the cause and effect of variables, such as the configuration of board members, audit committee, independent directors and the role of top management and their social relationships rather than its regulatory frameworks. Hence, it is suggestedthat a combination of various theories is best to describe an effective and good governance practice rather than theorizing corporate governance based on a single theory.1.0. IntroductionCorporations have become a powerful and dominant institution. They have reached to every corner of the globe in various sizes, capabilities and influences. Their governance has influenced economies and various aspects of social landscape. Shareholders are seen to be losing trust and market value has beentremendously affected. Moreover with the emergence of globalization, there is greater deterritorialization and less of governmental control, which results is a greater need for accountability (Crane and Matten, 2007). Hence, corporate governance has become an important factor in managing organizations in the current global and complex environment. In order to understand corporategovernance, it is important to highlight its definition. Even though, there is no single accepted definition of corporate governance but it can be defined as a set of processes and structures for controlling and directing an organization. It constitutes a set of rules, which governs the relationshipsbetween management, shareholders and stakeholders (Ching et al, 2006). The term “corporate governance” has a clear origin from a Greek word, “kyberman” meaning to steer, guide or govern. From a Greek word, it moved over to Latin, where it was known as “gubernare” and the French version of “governer” . It could also mean the process of decision-making and the process by which decisions may be implemented. Henceforth, corporate governance has much a different meaning to different organizations (Abu-Tapanjeh, 2008). In recent years, with much corporate failures, the countenance of corporate has been scared. Corporate governance includes all types of firms and its definitions could extend to cover all of the economic and non-economic activities. Literatures in corporate governance provide some form of meaning on governance, but fall short in its precise meaning of governance. Such ambiguity emerges

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in words like control, regulate, manage, govern and governance. Owing to such ambiguity, there are many interpretations. It may be important to consider the influences a firm has or affected by in order to grasp a better understanding of governance. Owing to vast influential factors, proposed models of corporate governance can be flawed as each social scientist is forming their own scope and concerns. Hence, this article reviews various fundamental theories underlining corporate governance. Thesetheories range from the agency theory and expanded into stewardship theory, stakeholder theory, resource dependency theory, transaction cost theory, political theory and ethics related theories such as business ethics theory, virtue ethics theory, feminists ethics theory, discourse theory and postmodernism ethics theory.2.0. Fundamental Corporate Governance Theories2.1. Agency TheoryAgency theory having its roots in economic theory was exposited by Alchian and Demsetz (1972) and further developed by Jensen and Meckling (1976). Agency theory is defined as “the relationship between the principals, such as shareholders and agents such as the company executives andmanagers”. In this theory, shareholders who are the owners or principals of the company, hires the gents to perform work. Principals delegate the running of business to the directors or managers, who are the shareholder’s agents (Clarke, 2004). Indeed, Daily et al (2003) argued that two factors can influence the prominence of agency theory. First, the theory is conceptually and simple theory that reduces the corporation to two participants of managers and shareholders. Second, agency theory suggests that employees or managers in organizations can be self-interested. The agency theory shareholders expect the agents to act and make decisions in the principal’s interest. On the contrary, the agent may not necessarily make decisions in the best interests of the principals (Padilla, 2000). Such a problem was first highlighted by Adam Smith in the 18th century andsubsequently explored by Ross (1973) and the first detailed description of agency theory was presented by Jensen and Meckling (1976). Indeed, the notion of problems arising from the separation of ownership and control in agency theory has been confirmed by Davis, Schoorman and Donaldson(1997). In agency theory, the agent may be succumbed to self-interest, opportunistic behavior and falling short of congruence between the aspirations of the principal and the agent’s pursuits. Even the understanding of risk defers in its approach. Although with such setbacks, agency theory was introduced basically as a separation of ownership and control (Bhimani, 2008). Holmstrom andMilgrom (1994) argued that instead of providing fluctuating incentive payments, the agents will only focus on projects that have a high return and have a fixed wage without any incentive component. Although this will provide a fair assessment, but it does not eradicate or even minimize corporatemisconduct. Here, the positivist approach is used where the agents are controlled by principal-made rules, with the aim of maximizing shareholders value. Hence, a more individualistic view is applied in this theory (Clarke, 2004). Indeed, agency theory can be employed to explore the relationship between

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the ownership and management structure. However, where there is a separation, the agency model can be applied to align the goals of the management with that of the owners. Due to the fact that in a family firm, the management comprises of family members, hence the agency cost would be minimal as any firm’s performance does not really affect the firm performance (Eisenhardt, 1989). The model of anemployee portrayed in the agency theory is more of a self-interested, individualistic and are bounded rationality where rewards and punishments seem to take priority (Jensen & Meckling, 1976). This theory prescribes that people or employees are held accountable in their tasks and responsibilities.Employees must constitute a good governance structure rather than just providing the need of shareholders, which maybe challenging the governance structure.2.2. Stewardship TheoryStewardship theory has its roots from psychology and sociology and is defined by Davis, Schoorman & Donaldson (1997) as “a steward protects and maximises shareholders wealth through firm performance, because by so doing, the steward’s utility functions are maximised”. In this perspective,stewards are company executives and managers working for the shareholders, protects and make profits for the shareholders. Unlike agency theory, stewardship theory stresses not on the perspective of individualism (Donaldson & Davis, 1991), but rather on the role of top management being as stewards,integrating their goals as part of the organization. The stewardship perspective suggests that stewards are satisfied and motivated when organizational success is attained. Agyris (1973) argues agency theory looks at an employee or people as an economic being, which suppresses an individual’s own aspirations. However, stewardship theory recognizes the importance of structures that empower the steward and offers maximum autonomy built on trust(Donaldson and Davis, 1991). It stresses on the position of employees or executives to act more autonomously so that the shareholders’ returns are maximized. Indeed, this can minimize the costs aimed at monitoring and controlling behaviours (Davis, Schoorman & Donaldson, 1997).On the other end, Daly et al. (2003) argued that in order to protect their reputations as decision makers in organizations, executives and directors are inclined to operate the firm to maximize financial performance as well as shareholders’ profits. In this sense, it is believed that the firm’s performancecan directly impact perceptions of their individual performance. Indeed, Fama (1980) contend that executives and directors are also managing their careers in order to be seen as effective stewards of their organization, whilst, Shleifer and Vishny (1997) insists that managers return finance to investorsto establish a good reputation so that that can re-enter the market for future finance. Stewardship model can have linking or resemblance in countries like Japan, where the Japanese worker assumes the role ofstewards and takes ownership of their jobs and work at them diligently.Moreover, stewardship theory suggests unifying the role of the CEO and the chairman so as to reduce agency costs and to have greater role as stewards in

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the organization. It was evident that there would be better safeguarding of the interest of the shareholders. It was empirically found that thereturns have improved by having both these theories combined rather than separated (Donaldson and Davis, 1991).2.3. Stakeholder TheoryStakeholder theory was embedded in the management discipline in 1970 and gradually developed by Freeman (1984) incorporating corporate accountability to a broad range of stakeholders. Wheeler et al, (2002) argued that stakeholder theory derived from a combination of the sociological and organizational disciplines. Indeed, stakeholder theory is less of a formal unified theory and more of a broad research tradition, incorporating philosophy, ethics, political theory, economics, law and organizational science. Stakeholder theory can be defined as “any group or individual who can affect or is affected by the achievement of the organization’s objectives”. Unlike agency theory in which the managers areworking and serving for the stakeholders, stakeholder theorists suggest that managers in organizations have a network of relationships to serve – this include the suppliers, employees and business partners. And it was argued that this group of network is important other than owner-manager-employee relationship as in agency theory (Freeman, 1999). On the other end, Sundaram & Inkpen (2004) contend that stakeholder theory attempts to address the group of stakeholder deserving and requiring management’s attention. Whilst, Donaldson & Preston (1995) claimed that all groups participate in a business to obtain benefits. Nevertheless, Clarkson (1995) suggested that the firm is a system, where there are stakeholders and the purpose of the organization is to create wealth for its stakeholders. Freeman (1984) contends that the network of relationships with many groups can affect decision making processes as stakeholder theory is concerned with the nature of these relationships interms of both processes and outcomes for the firm and its stakeholders. Donaldson & Preston (1995) argued that this theory focuses on managerial decision making and interests of all stakeholders haveintrinsic value, and no sets of interests is assumed to dominate the others.92 Middle Eastern Finance and Economics - Issue 4 (2009)2.4. Resource Dependency TheoryWhilst, the stakeholder theory focuses on relationships with many groups for individual benefits, resource dependency theory concentrates on the role of board directors in providing access to resources needed by the firm. Hillman, Canella and Paetzold (2000) contend that resource dependency theoryfocuses on the role that directors play in providing or securing essential resources to an organization through their linkages to the external environment. Indeed, Johnson et al, (1996) concurs that resource dependency theorists provide focus on the appointment of representatives of independent organizations as a means for gaining access in resources critical to firm success. For example, outside directors who are partners to a law firm provide legal advice, either in board meetings or in private communicationwith the firm executives that may otherwise be more costly for the firm to secure.

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It has been argued that the provision of resources enhances organizational functioning, firm’s performance and its survival (Daily et al, 2003). According to Hillman, Canella and Paetzold (2000) that directors bring resources to the firm, such as information, skills, access to key constituents such assuppliers, buyers, public policy makers, social groups as well as legitimacy. Directors can be classifiedinto four categories of insiders, business experts, support specialists and community influentials. First, the insiders are current and former executives of the firm and they provide expertise in specific areas such as finance and law on the firm itself as well as general strategy and direction. Second, thebusiness experts are current, former senior executives and directors of other large for-profit firms and they provide expertise on business strategy, decision making and problem solving. Third, the support specialists are the lawyers, bankers, insurance company representatives and public relations expertsand these specialists provide support in their individual specialized field. Finally, the community influentials are the political leaders, university faculty, members of clergy, leaders of social or community organizations.2.5. Transaction Cost TheoryTransaction cost theory was first initiated by Cyert and March (1963) and later theoretical described and exposed by Williamson (1996). Transaction cost theory was an interdisciplinary alliance of law, economics and organizations. This theory attempts to view the firm as an organization comprising people with different views and objectives. The underlying assumption of transaction theory is thatfirms have become so large they in effect substitute for the market in determining the allocation of resources. In other words, the organization and structure of a firm can determine price and production. The unit of analysis in transaction cost theory is the transaction. Therefore, the combination of people with transaction suggests that transaction cost theory managers are opportunists and arrange firms’ transactions to their interests (Williamson, 1996).2.6. Political TheoryPolitical theory brings the approach of developing voting support from shareholders, rather by purchasing voting power. Hence having a political influence in corporate governance may direct corporate governance within the organization. Public interest is much reserved as the governmentparticipates in corporate decision making, taking into consideration cultural challenges (Pound, 1993). The political model highlights the allocation of corporate power, profits and privileges are determined via the governments’ favor. The political model of corporate governance can have animmense influence on governance developments. Over the last decades, the government of a country has been seen to have a strong political influence on firms. As a result, there is an entrance of politics into the governance structure or firms’ mechanism (Hawley and Williams, 1996).3.0. Ethics Theories and Corporate GovernaceOther than the fundamental corporate governance theories of agency theory, stewardship theory, stakeholder theory, resource dependency theory, transaction

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cost theory and political theory, there are other ethical theories that can be closely associated to corporate governance. These include businessethics theory, virtue ethics theory, feminist ethics theory, discourse ethics theory, postmodern ethics theory. Business ethics is a study of business activities, decisions and situations where the right and wrongs are addressed. The main reasons for this are the power and influence of business in any givensociety is stronger than ever before. Businesses have become a major provider to the society, in terms of jobs, products and services. Business collapse has a greater impact on society than ever before and the demands placed by the firm’s stakeholders are more complex and challenging. Only a handful ofbusiness giants have had any formal education on business ethics but there seems to be more compromises these days. Business ethics helps us to identify benefits and problems associated with ethical issues within the firm and business ethics is important as it gives us a new light into present and traditional view of ethics (Crane and Matten, 2007). In understanding the ‘right and wrongs’ inbusiness ethics, Crane & Matten, (2007) injected morality that is concerned with the norms, values and beliefs fixed in the social process which helps right and wrong for an individual or social community. Ethics is defined as the study of morality and the application of reason which sheds light on rules andprinciple, which is called ethical theories that ascertains the right and wrong for a situation. Whilst business ethics theory focuses on the “rights and wrongs’ in business, feminist ethics theory emphasizes on empathy, healthy social relationship, loving care for each other and the avoidance of harm. In an organization, to care for one another is a social concern and not merely aprofit centered motive. Ethics has also to be seen in the light of the environment in which it is exercised. This is important as an organization is a network of actions, hence influencing transcommunal levels and interactions (Casey, 2006). On the other end, discourse ethics theory is concerned with peaceful settlement of conflicts. Discourse ethics, also called argumentation ethics, refers to a type of argument that tries to establish ethical truths by investigating the presuppositions of discourse (Habermas, 1996). Meisenbach (2006) contends that such kind of settlement would be beneficial to promote cultural rationality and cultivate openness. Virtue ethics theory focuses on moral excellence, goodness, chastity and good character. Virtue is a state to act in a given situation. It is not a habit as a habit can be mindless (Annas, 2003). Aristotle calls it as disposition with choice or decision. For example, if a board member decides to be honest, now that a decision which he makes and thus strengthens his virtue of honesty. Virtue involves two aspects, the affective and intellectual. The concept of affective in virtue theory suggests “doing the right thing and have positive feelings”, whilst, the concept of intellectual suggests “to do virtuous act with the right reason”. Virtues can be instilled with education. Aristotle mentions that knowledge onethics is just like becoming a builder (Annas, 2003). Through the process of educating and exposure to good virtues, the development of ethical values in a child’s life is evident. Hence, if a person isexposed to good or positive ethical standards, exhibiting honesty, just and fairness, than he would exercise the same and it will be embedded in his will to

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do the right thing at any given situation. Virtue ethics is eminent to bring about the intangibles into an organization. Virtue ethics highlights the virtuous character towards developing a morally positive behavior (Crane and Matten, 2007). Virtues are a set of traits that helps a person to lead a good life. Virtues are exhibited in a person’s life.Aristotle believed that virtue ethics consists of happiness not on a hedonistic sense, but rather on a broader level. Nevertheless, postmodern ethics theory goes beyond the facial value of morality and addressed the inner feelings and ‘gut feelings’ of a situation. It provides a more holistic approach in which firms may make goals achievement as their priority, foregoing or having a minimal focus on values, hence having a long term detrimental effect. On the other hand, there are firms today who are so value driven that their values become their ultimate goal (Balasubramaniam, 1999).4.0. ConclusionThis review has seen corporate governance from various theoretical perspectives. The emergence of agency theory, stewardship theory, stakeholder theory, transaction cost theory and political theory addresses the cause and effect of variables, such as the configuration of board members, auditcommittee, independent directors and the role of top management. In addition, ethics in business have been closely associated with corporate governance. This can be seen with the association of business ethics theory, feminist ethics theory, discourse ethics theory, virtue ethics theory and postmodern ethics theory. Hence, it can be argued that corporate governance is more of a social relationships rather than process orientated structure. In addition, these theories focused on the view that the shareholders’ aimed to get a return on their investments. In todays business environment, business process shouldalso focus on other critical factors such as legislation, culture and institutional contexts. Corporate governance is constantly changing and evolving and changes are driven by both internal and external environmental dynamics. The internal environment has a fixed mindset of shareholders’ relationshipwith stakeholders and maximizing profits. Whilst, issues in the external environment such as the breakup of large conglomerates like Enron, mergers and acquisitions of corporation, business collaborations, easier financial funding, human resource diversity, new business start-ups, globalization and businessinternationalization, and the advance of communication and information technology have directly and indirectly caused the changes in corporate governance. The current corporate governance theories cannot fully explain the complexity and heterogeneity of corporate business. Governance for differentcountry may vary due to its cultural values, political and social and historical circumstances. In this sense, governance for developed countries and developing countries can vary due to the culture and economic contexts of individual country. Moreover, an effective and good corporate governance cannot be explained by one theory but it is best to combine a variation of theories, addressing not only the social relationships but also emphasize on the rules and legislation and stricter enforcement surrounding good governance practice

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and going beyond the norms of a mechanical approach towards corporate governance. Literature has proven that even with strict regulations, there have been infringements in corporate governance. Hence it is crucial that a holistic realization be driven across the corporate world that would bring about adifferent perspective towards corporate governance. The days of cane and bridle are becoming a mereshadow and the need to get to the root of a corporation is essential. Therefore, it is important to re-visit corporate governance in the light of the convergence of these theories and with a fresh angle, which has a holistic view and incorporating subjectivity from the perspective of social sciences.

Corporate Governance and Separation of Ownership and Control

What is the primary goal of the corporation? The traditional answer is that

managers in a corporation snake decisions for the stockholders of the

corporation. However, it is impossible to give a definitive answer to this important

question because the corporation is an artificial being, not a natural person.

It is necessary to precisely identify who controls the corporation. We shall con-

sider the set-of-contracts viewpoint. This viewpoint suggests the corporate firm

will attempt to maximize the shareholders’ wealth in the firm by taking actions

that increase the current value per share of existing stock.

Agency Costs and the Set-of-Contracts Perspective

The set-of-contracts theory of the firm states that the firm can he viewed as a set

of contracts: One of the contract claims is a residual claim (equity) on the firm’s

assets and cash flows. The equity contract can be defined as a principal-agent

relationship. The members of the management team are the agents, and the

equity investors (shareholders) are the principals. It is assumed that the

managers and the shareholders, left alone, will each attempt to act in their own

self-interest.

The shareholders, however, can discourage the managers from diverging from

the shareholders’ interests by devising appropriate incentives for managers and

then monitoring their behavior. Doing so, unfortunately, is complicated and

costly. The costs of resolving the conflicts of interest between managers and

shareholders are special types of costs called agency costs. These costs are

defined as the sum of (1) the monitoring costs of the shareholders and (2) the

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incentive fees paid to the managers. It can be expected that contracts will he

devised that will provide the managers with appropriate incentives to maximize

the shareholders’ wealth. Thus, the set of contracts theory suggests that the

corporate firm will usually act in the best interests of shareholders. However,

agency problems can never he perfectly solved, and managers may not always

act in the best interests of shareholders. As a consequence shareholders may

experience residual losses. Residual losses are the lost wealth of the

shareholders due to divergent behavior of the managers.

Managerial Goals

Managerial goals may be different from those of shareholders. What will

managers maximize if they are left to pursue their own goals rather than

shareholders’ goals?

Some financial economists propose the notion of expense preference. They

argue that managers obtain value from certain kinds of expenses. In particular,

company cars, office furniture, office location, and funds for discretionary

investment have value to managers beyond that which comes from their

productivity.

Economists conducted a series of interviews with the chief executives of several

large companies. From these interview they concluded that managers are

influenced by two basic underlying motivations:

1. Survival. Organizational survival means that management will always try to

command sufficient resources to avoid the firm’s going out of business.

2. Independence and self-sufficiency. This is the freedom to make decisions

without encountering external parties or depending on outside financial

markets. The above-mentioned interviews suggested that managers do not

like to issue new shares of stock. Instead, they like to be able to rely on

internally generated cash flow.

These motivations lead to what is thought to be the basic financial objective of

managers: the maximization of corporate wealth. Corporate wealth is defined as

that wealth over which management has effective control; it is closely associated

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with corporate growth and corporate size. Corporate wealth is not necessarily

shareholder wealth. Corporate wealth tends to lead to increased growth by

providing funds for growth and limiting the extent to which new equity is raised.

Increased growth and size are not necessarily the same thing as increased

shareholder wealth.

Separation of Ownership and Control

Some people argue that shareholders do not completely control the corporation.

They argue that shareholder ownership is too diffuse (spread out) and

fragmented for effective control of management. A striking feature of the modern

large corporation is the diffusion of ownership among thousands of investors.

One of the most important advantages of the corporate form of business

organization is that it allows ownership of shares to he transferred. The resulting

diffuse ownership, however, brings with it the separation of ownership and

control of the large corporation. The possible separation of ownership and control

raises an important question: Who controls the firm?

Do Shareholders Control Managerial Behavior?

The claim that managers can ignore the interests of shareholders is deduced

from the fact that ownership in large corporations is widely dispersed. As a

consequence, it is often claimed that individual shareholders cannot control

management. There is some merit in this argument, but it is too simplistic.

The extent to which shareholders can control managers depends on (1) the costs

of monitoring management, (2) the costs of implementing the control devices,

and (3) the benefits of control.

When a conflict of interest exists between management and shareholders, who

wins? Does management or do the shareholders control the firm? There is no

doubt and that ownership in large corporations is diffuse when compared to the

closely held corporation. However, several control devices used by shareholders

tie management to the self-interest of shareholders:

1. Shareholders determine the membership of the board of directors by

voting. Thus, shareholders control the directors, who in turn select the

management team.

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2. Contracts with management and arrangements for compensation, such

as stock option plans, can he made so that management has an incentive to

pursue the goal of the shareholders. Another device is called performance

shares. These are shares of the company (often the treasury stock) given to

managers on the basis of performance as measured by earnings per share

and similar criteria.

3. If the price of a firm’s stock drops too low because of poor management,

the firm may be acquired by a group of outside shareholders, by another firm, or

by an individual. This is called a takeover. In a takeover, the top management of

the acquired firm may find itself out of a job. This puts pressure on the

management to make decisions in the stockholders’ interests. Fear of a takeover

gives managers an incentive to take actions that will maximize stock prices.

4. Competition in the managerial labor market may force managers to

perform in the best interest of stockholders. Otherwise they will be replaced.

Firms willing to pay the most will lure good managers. These are likely to be firms

that compensate managers based on the value they create.

The available evidence and theory are consistent with the ideas of shareholder

control and shareholder value maximization However, there can be no doubt that

at times corporations pursue managerial goals at the expense of shareholders.

There is also evidence that the diverse claims of customers, vendors, and

employees must frequently be considered in the goals of the corporation.

Portable School Brief Series

The stakeholder theory is a theory of organizational management and business ethics that addresses morals and values in managing an organization.[1] It was originally detailed by R. Edward Freeman in the book Strategic Management: A Stakeholder Approach, and identifies and models the groups which are stakeholders of a corporation, and both describes and recommends methods by which management can give due regard to the interests of those groups. In short, it attempts to address the "Principle of Who or What Really Counts."[2]

Overview

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In the traditional view of the firm, the shareholder MH (Majority Holder) view (the only one recognized in business law in most countries), the shareholders or stockholders are the owners of the company, and the firm has a binding fiduciary duty to put their needs first, to increase value for them. In older input-output models of the corporation, the firm converts the inputs of investors, employees, and suppliers into usable (salable) outputs which customers buy, thereby returning some capital benefit to the firm. By this model, firms only address the needs and wishes of those four parties: investors, employees, suppliers, and customers. However, stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers, and the public at large. Sometimes even competitors are counted as stakeholders.

The stakeholder view of strategy is an instrumental theory of the corporation, integrating both the resource-based view as well as the market-based view, and adding a socio-political level. This view of the firm is used to define the specific stakeholders of a corporation (the normative theory (Donaldson) of stakeholder identification) as well as examine the conditions under which these parties should be treated as stakeholders (the descriptive theory of stakeholder salience). These two questions make up the modern treatment of Stakeholder Theory.

There have been numerous articles and books written on stakeholder theory. Recent scholarly works on the topic of stakeholder theory that exemplify research and theorizing in this area include Donaldson and Preston and Mitchell, Agle, and Wood (1997), Friedman and Miles (2002) and Phillips (2003).

Donaldson and Preston argue that the normative base of the theory, including the "identification of moral or philosophical guidelines for the operation and management of the corporation", is the core of the theory.[3] Mitchell, et al. derive a typology of stakeholders based on the attributes of power (the extent a party has means to impose its will in a relationship), legitimacy (socially accepted and expected structures or behaviors), and urgency (time sensitivity or criticality of the stakeholder's claims).[4] By examining the combination of these attributes in a binary manner, 8 types of stakeholders are derived along with their implications for the organization. Friedman and Miles explore the implications of contentious relationships between stakeholders and organizations by introducing compatible/incompatible interests and necessary/contingent connections as additional attributes with which to examine the configuration of these relationships.[5]

The political philosopher Charles Blattberg has criticized stakeholder theory for assuming that the interests of the various stakeholders can be, at best, compromised or balanced against each other. Blattberg argues that this is a product of its emphasis on negotiation as the chief mode of dialogue for dealing with conflicts between stakeholder interests. He recommends conversation

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instead and this leads him to defend what he calls a 'patriotic' conception of the corporation as an alternative to that associated with stakeholder theory.[6] Stakeholder theory is defined by Rossouw et al. in Ethics for Accountants and Auditors and by Mintz et al. in Ethical Obligations and Decision Making in Accounting.

Stewardship theory is a theory that managers, left on their own, will indeed act as responsible stewards of the assets they control.

This theory is an alternative view of agency theory, in which managers are assumed to act in their own self interests at the expense of shareholders.[1]

In American politics, an example of the stewardship theory is where a president practices a governing style based on belief they have the duty to do whatever is necessary in national interest, unless prohibited by the Constitution[2].

Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely defined) between resource holders. An agency relationship arises whenever one or more individuals, called principals, hire one or more other individuals, called agents, to perform some service and then delegate decision-making authority to the agents. The primary agency relationships in business are those (1) between stockholders and managers and (2) between debtholders and stockholders. These relationships are not necessarily harmonious; indeed, agency theory is concerned with so-called agency conflicts, or conflicts of interest between agents and principals. This has implications for, among other things, corporate governance and business ethics. When agency occurs it also tends to give rise to agency costs, which are expenses incurred in order to sustain an effective agency relationship (e.g., offering management performance bonuses to encourage managers to act in the shareholders' interests). Accordingly, agency theory has emerged as a dominant model in the financial economics literature, and is widely discussed in business ethics texts.

Agency theory in a formal sense originated in the early 1970s, but the concepts behind it have a long and varied history. Among the influences are property-rights theories, organization economics, contract law, and political philosophy, including the works of Locke and Hobbes. Some noteworthy scholars involved in agency theory's formative period in the 1970s included Armen Alchian, Harold Demsetz, Michael Jensen, William Meckling, and S.A. Ross.

CONFLICTS BETWEEN MANAGERS AND SHAREHOLDERS

Agency theory raises a fundamental problem in organizationsâself-interested behavior. A corporation's managers may have personal goals that compete with the owner's goal of maximization of shareholder wealth. Since the shareholders authorize managers to administer the firm's assets, a potential conflict of interest exists between the two groups.

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SELF-INTERESTED BEHAVIOR.

Agency theory suggests that, in imperfect labor and capital markets, managers will seek to maximize their own utility at the expense of corporate shareholders. Agents have the ability to operate in their own self-interest rather than in the best interests of the firm because of asymmetric information (e.g., managers know better than shareholders whether they are capable of meeting the shareholders' objectives) and uncertainty (e.g., myriad factors contribute to final outcomes, and it may not be evident whether the agent directly caused a given outcome, positive or negative). Evidence of self-interested managerial behavior includes the consumption of some corporate resources in the form of perquisites and the avoidance of optimal risk positions, whereby risk-averse managers bypass profitable opportunities in which the firm's shareholders would prefer they invest. Outside investors recognize that the firm will make decisions contrary to their best interests. Accordingly, investors will discount the prices they are willing to pay for the firm's securities.

A potential agency conflict arises whenever the manager of a firm owns less than 100 percent of the firm's common stock. If a firm is a sole proprietorship managed by the owner, the owner-manager will undertake actions to maximize his or her own welfare. The owner-manager will probably measure utility by personal wealth, but may trade off other considerations, such as leisure and perquisites, against personal wealth. If the owner-manager forgoes a portion of his or her ownership by selling some of the firm's stock to outside investors, a potential conflict of interest, called an agency conflict, arises. For example, the owner-manager may prefer a more leisurely lifestyle and not work as vigorously to maximize shareholder wealth, because less of the wealth will now accrue to the owner-manager. In addition, the owner-manager may decide to consume more perquisites, because some of the cost of the consumption of benefits will now be borne by the outside shareholders.

In the majority of large publicly traded corporations, agency conflicts are potentially quite significant because the firm's managers generally own only a small percentage of the common stock. Therefore, shareholder wealth maximization could be subordinated to an assortment of other managerial goals. For instance, managers may have a fundamental objective of maximizing the size of the firm. By creating a large, rapidly growing firm, executives increase their own status, create more opportunities for lower- and middle-level managers and salaries, and enhance their job security because an unfriendly takeover is less likely. As a result, incumbent management may pursue diversification at the expense of the shareholders who can easily diversify their individual portfolios simply by buying shares in other companies.

Managers can be encouraged to act in the stockholders' best interests through incentives, constraints, and punishments. These methods, however, are effective only if shareholders can observe all of the actions taken by managers. A moral

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hazard problem, whereby agents take unobserved actions in their own self-interests, originates because it is infeasible for shareholders to monitor all managerial actions. To reduce the moral hazard problem, stockholders must incur agency costs.

COSTS OF SHAREHOLDER-MANAGEMENT CONFLICT.

Agency costs are defined as those costs borne by shareholders to encourage managers to maximize shareholder wealth rather than behave in their own self-interests. The notion of agency costs is perhaps most associated with a seminal 1976 Journal of Finance paper by Michael Jensen and William Meckling, who suggested that corporate debt levels and management equity levels are both influenced by a wish to contain agency costs. There are three major types of agency costs: (1) expenditures to monitor managerial activities, such as audit costs; (2) expenditures to structure the organization in a way that will limit undesirable managerial behavior, such as appointing outside members to the board of directors or restructuring the company's business units and management hierarchy; and (3) opportunity costs which are incurred when shareholder-imposed restrictions, such as requirements for shareholder votes on specific issues, limit the ability of managers to take actions that advance shareholder wealth.

In the absence of efforts by shareholders to alter managerial behavior, there will typically be some loss of shareholder wealth due to inappropriate managerial actions. On the other hand, agency costs would be excessive if shareholders attempted to ensure that every managerial action conformed with shareholder interests. Therefore, the optimal amount of agency costs to be borne by shareholders is determined in a cost-benefit contextâagency costs should be increased as long as each incremental dollar spent results in at least a dollar increase in shareholder wealth.

MECHANISMS FOR DEALING WITH SHAREHOLDER-MANAGER CONFLICTS

There are two polar positions for dealing with shareholder-manager agency conflicts. At one extreme, the firm's managers are compensated entirely on the basis of stock price changes. In this case, agency costs will be low because managers have great incentives to maximize shareholder wealth. It would be extremely difficult, however, to hire talented managers under these contractual terms because the firm's earnings would be affected by economic events that are not under managerial control. At the other extreme, stockholders could monitor every managerial action, but this would be extremely costly and inefficient. The optimal solution lies between the extremes, where executive compensation is tied to performance, but some monitoring is also undertaken. In addition to monitoring, the following mechanisms encourage managers to act in shareholders' interests: (1) performance-based incentive plans, (2) direct

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intervention by shareholders, (3) the threat of firing, and (4) the threat of takeover.

Most publicly traded firms now employ performance shares, which are shares of stock given to executives on the basis of performances as defined by financial measures such as earnings per share, return on assets, return on equity, and stock price changes. If corporate performance is above the performance targets, the firm's managers earn more shares. If performance is below the target, however, they receive less than 100 percent of the shares. Incentive-based compensation plans, such as performance shares, are designed to satisfy two objectives. First, they offer executives incentives to take actions that will enhance shareholder wealth. Second, these plans help companies attract and retain managers who have the confidence to risk their financial future on their own abilitiesâwhich should lead to better performance.

An increasing percentage of common stock in corporate America is owned by institutional investors such as insurance companies, pension funds, and mutual funds. The institutional money managers have the clout, if they choose, to exert considerable influence over a firm's operations. Institutional investors can influence a firm's managers in two primary ways. First, they can meet with a firm's management and offer suggestions regarding the firm's operations. Second, institutional shareholders can sponsor a proposal to be voted on at the annual stockholders' meeting, even if the proposal is opposed by management. Although such shareholder-sponsored proposals are nonbinding and involve issues outside day-to-day operations, the results of these votes clearly influence management opinion.

In the past, the likelihood of a large company's management being ousted by its stockholders was so remote that it posed little threat. This was true because the ownership of most firms was so widely distributed, and management's control over the voting mechanism so strong, that it was almost impossible for dissident stockholders to obtain the necessary votes required to remove the managers. In recent years, however, the chief executive officers at American Express Co., General Motors Corp., IBM, and Kmart have all resigned in the midst of institutional opposition and speculation that their departures were associated with their companies' poor operating performance.

Hostile takeovers, which occur when management does not wish to sell the firm, are most likely to develop when a firm's stock is undervalued relative to its potential because of inadequate management. In a hostile takeover, the senior managers of the acquired firm are typically dismissed, and those who are retained lose the independence they had prior to the acquisition. The threat of a hostile takeover disciplines managerial behavior and induces managers to attempt to maximize shareholder value.

STOCKHOLDERS VERSUS CREDITORS: A SECOND AGENCY CONFLICT

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In addition to the agency conflict between stockholders and managers, there is a second class of agency conflictsâthose between creditors and stockholders. Creditors have the primary claim on part of the firm's earnings in the form of interest and principal payments on the debt as well as a claim on the firm's assets in the event of bankruptcy. The stockholders, however, maintain control of the operating decisions (through the firm's managers) that affect the firm's cash flows and their corresponding risks. Creditors lend capital to the firm at rates that are based on the riskiness of the firm's existing assets and on the firm's existing capital structure of debt and equity financing, as well as on expectations concerning changes in the riskiness of these two variables.

The shareholders, acting through management, have an incentive to induce the firm to take on new projects that have a greater risk than was anticipated by the firm's creditors. The increased risk will raise the required rate of return on the firm's debt, which in turn will cause the value of the outstanding bonds to fall. If the risky capital investment project is successful, all of the benefits will go to the firm's stockholders, because the bondholders' returns are fixed at the original low-risk rate. If the project fails, however, the bondholders are forced to share in the losses. On the other hand, shareholders may be reluctant to finance beneficial investment projects. Shareholders of firms undergoing financial distress are unwilling to raise additional funds to finance positive net present value projects because these actions will benefit bondholders more than shareholders by providing additional security for the creditors' claims.

Managers can also increase the firm's level of debt, without altering its assets, in an effort to leverage up stockholders' return on equity. If the old debt is not senior to the newly issued debt, its value will decrease, because a larger number of creditors will have claims against the firm's cash flows and assets. Both the riskier assets and the increased leverage transactions have the effect of transferring wealth from the firm's bondholders to the stockholders.

Shareholder-creditor agency conflicts can result in situations in which a firm's total value declines but its stock price rises. This occurs if the value of the firm's outstanding debt falls by more than the increase in the value of the firm's common stock. If stockholders attempt to expropriate wealth from the firm's creditors, bondholders will protect themselves by placing restrictive covenants in future debt agreements. Furthermore, if creditors believe that a firm's managers are trying to take advantage of them, they will either refuse to provide additional funds to the firm or will charge an above-market interest rate to compensate for the risk of possible expropriation of their claims. Thus, firms which deal with creditors in an inequitable manner either lose access to the debt markets or face high interest rates and restrictive covenants, both of which are detrimental to shareholders.

Management actions that attempt to usurp wealth from any of the firm's other stakeholders, including its employees, customers, or suppliers, are handled

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through similar constraints and sanctions. For example, if employees believe that they will be treated unfairly, they will demand an above-market wage rate to compensate for the unreasonably high likelihood of job loss.

AGENCY VERSUS CONTRACT

Although the notions of agency and contract are closely intertwined, some academics bristle at the suggestion they are essentially the same. Specifically, they point out a number of unique features of agency versus contractual relationships. There are two major sets of differences. First, agents are usually retained not for any particular or discrete set of tasks, but for a broad range of activities, which may change over time, that are consistent with basic objectives and interests set forth by the principals. In this instance principals must be concerned to some degree about agents' personal attitudes, dispositions, and other characteristics that are usually not a concern in contractual agreements. Principals hire out broad objectives to be fulfilled instead of specific tasks. Second, in an agency relationship there is typically much less independence between agent and principal than between contracting parties. Typically this also means that the principal-agent relationship is more hierarchical and power-driven than a contractual relationship, and included in this power is greater latitude for principals to reward, punish, and control agents.

A conventional view holds that agency is a special application of contract theory. However, some argue that the reverse is true: a contract is a formalized, structured, and limited version of agency, but agency itself is not based on contracts.

AGENCY AND ETHICS

Since agency relationships are usually more complex and ambiguous (in terms of what specifically the agent is required to do for the principal) than contractual relationships, agency carries with it special ethical issues and problems, concerning both agents and principals. Ethicists point out that the classical version of agency theory assumes that agents (i.e., managers) should always act in principals' (owners') interests. However, if taken literally, this entails a further assumption that either (a) the principals' interests are always morally acceptable ones or (b) managers should act unethically in order to fulfill their "contract" in the agency relationship. Clearly, these stances do not conform to any practicable model of business ethics.

A familiar real-life example is large corporations' layoff dilemma. Conventional wisdom holds that investors are rewarded when companies thin their employment rosters because operating costs are lowered, in theory leading to greater profits. This expectation is often made explicit in news reporting surrounding a downsizing episode; the reports highlight whether investors seem pleased or displeased with an announcement of a mass layoff, and the often-

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stated assumption is that corporate management has undertaken the layoffs in part, if not in whole, to please shareholders and enhance their wealth. In this instance it is obvious that shareholders' interests are advanced to the detriment of at least one other constituency, namely the employees. In such cases, observers question whether it is ethical to serve the principals' interests when those actions harm a large number of people, and whether the benefits shareholders receive are commensurate with the harm inflicted on the laid-off employees.

Along the same lines, others have noted that traditional agency theory makes little mention of what obligations, moral or otherwise, principals have to their agents. The emphasis lies almost exclusively on what agents should or must do for the principals, relying, in turn, on a vague assumption that principals will compensate agents adequatelyâeven more than adequatelyâfor their services. Some ethics scholars argue that principals have obligations as well. In the example above, some would argue that not only is it unethical to harm employees to obtain improvements (often marginal) in shareowners' wealth, but also that the shareholders have moral obligations directly to the employees as an extension of the ethical employer/employee relationship (i.e., not to harm them arbitrarily, among other obligations). This ethical problem is only complicated by the reality that, as noted above, principals are often institutions rather than individuals.

Meanwhile, consistent with the conventional formulation of the theory, agents are seen as having ethical duties to the principals. If managers act in self-interestâa rather negative assumptionâand it fails to serve the best interests of the shareholders, they may, according to some views, have fallen short on their ethical responsibilities.

In a larger sense, some see the traditional agency model as a simplistic, even deceptive, justification for traditional economic power relationships, specifically that large wealth holders can extract concessions from weaker economic beings. Certain scholars have argued that from a broader social perspective, there are many kinds of principal-agent relations, and included among these is the fact that shareholders may be seen as agents to managers, employees, and the broader society.

What is corporate governance? – The Anglo/American versus the German model 1

Compare and contrast the Anglo/American model of corporate governance with that of at least one other country. Comment on which model is likely to lead to superior corporate performance.

Recently the image of top-managers has been attacked by several cases of fraud. To name only some, Enron and WorldCom are probably the best known

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ones. In both companies, managers acted impudent shameless and greedily. And this seems to be dreadful not only for shareholders and stakeholders of that particular firm, but also for the entire economy. Therefore Biggs, a strategist at Morgan Stanley, says, ‘corruption and greed have poisoned the climate at Wall Street.’ (Cited in N.N., 2002, p1) Based on this, the essay is dealing with the question of corporate governance. There- fore, after a further introduction, the basic idea and especially its two concepts will be explained. Later on, these models will be contrasted against each other and an evalua- tion which model is likely to lead to better corporate performance is made.

Breuer argues such mentioned situation of greed, boundlessness and breach of trust that is found currently comes from an individual lack of moral and ethics. (Breuer, 2003, pp42) And after all these scandals, politicians, bankers and managers have to co-operate to gain back trust. Thus they are looking to improve corporate governance. But maybe, the problems can be compared with the ones in the end of the ‘Golden Twenties’. (N.N., 2003, p20) They ended 1929 with a crash at the stock exchanges, which was followed by a huge depression. And, after this stiff time, strong balance checks and as well as a stock exchange committee were introduced in the US.

But, spoken generally, what is ‘corporate governance’? And why are there different ways to execute this concept? To explain sufficiently, it might be appropriate to ex- pand. Nowadays ownership and control of large companies, but not necessarily only in joint stock ones, often is separated. A reason might be, that there is, on one hand, a huge demand for money, which mostly cannot be financed alone by a single person or even one family. On the other hand, these firms need specific managerial skills that are often not in-house. Additionally, especially joint stock companies have got several advantages, such as the sharing of total risk as well as the relatively easy generation of

risk capital. However, the interests of managers and owners diverge. Managers are assumed to search for prestige; power and good wages, while shareholders only are looking for profits. (Douma and Schreuder, 2002, p110) Especially this fact of managers’ aims makes the current system of corporations rather complex. (Douma and Schreuder, 2002, p119) The higher the number of shareholders is, the lower is the incentive for a single one to monitor top-management’s behaviour. (Monks and Minow, 2001, p95) There would be so many free riders that benefit from such action as well while the monitor has to bear these agency costs alone. However, because of a small number of shares hold, monitors’ influence within the firm might be limited. And therefore the success of monitoring is low. In addition to the effort of individual monitoring, Farrar defines corporate governance as a complex circle of different aspects. (Farrar, 2001, pp4) This contains, as the very basis for everything, the legal regulations, which monitor indirectly as well. Followed by stock exchange listing requirements and statements of accounting practise. Additionally guidelines of best practise and

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codes of conduct play a role. Furthermore, individual and business ethics seem to be the overall framework of business behaviour.

Nevertheless, corporate governance as ‘the system by which companies are directed and controlled’ (Cited in Smerdon, 1998, p11) consists of more. It also deals with the balance of all different driving forces within a company and how their competences and control are allocated. Additionally questions of remuneration, as a motivation of managers, are asked as well as of transparency within the firm. (Witt, 2000, pp159) But finally can be argued; corporate governance is looking at the ‘right’ balance bet- ween principals and agents. In this context, corporate governance means the organisa- tion of management and control. (Witt, 2000, pp159) Therefore especially the yet mentioned question of manager-motivation seems to be interesting. Mainly this was the problem for the two mentioned corporations. Their top-managers tried to get much more compensation than they should, related to their contracts.

When it comes to the comparison of the two models of corporate governance, three mechanisms (Douma and Schreuder, 2002, pp111) are seen as prevention of such be- haviour. They are important for both but have got a completely different influence in these systems: First (1), the stock market. If a firm is not successful, the share price will go down. And this leads to the fear of being taken over hostile on the market for corporate control. Later on the responsible managers will have to leave, which is not

wanted by them. Secondly (2), if these managers have left, the market for managerial labour becomes important. So they have to care about their own reputation in order to get a job afterwards. And finally (3), the intensity of competition on product markets. The stronger this competition is, the less are managers able to spend money for them- selves, so-called on-the-job-consumption. Otherwise the cost of products would be higher then the ones of competitors, which again leads back to the first point.

In large corporations questions of corporate governance arise for several reasons more often: To start with, usually owners (principals) are not involved in tasks of manage- ment. Therefore employed managers (agents) are responsible for the firm. They act, according to the principal-agent-theory, on behalf of the owners. But these have no guarantees for good behaviour of their agents (agency-problem). They often have to trust - and hope the best. (Cited in N.N., 2003, p20) Following, employees seldom are stockholders of their employer, which gives them less influence on the firm strategy. Continuing, also the tricky distribution of management power and control leads to questions as mentioned. And finally the existence of banks that have lent money to the company, but are stockholders as well is problematic.

Within the Anglo/American approach of corporate governance, the shareholder-value- model is favouring the maximization of asset-value as the main aim. This

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means, all actions of hired and paid managers are primary for the shareholders, the owners of the firm. (Smerdon, 1998, p3) And generated returns are seen as belonging to them. They are an incentive for future investments, a reward or even the price for risk bearing (economical, technological) and the price for waiting as well. (O’Sullivan, 2000, p43) In this context, value creation and value distribution are linked only with investors. Therefore this theory promotes the idea of market control as outlined above, rather than control via stakeholders. Additionally, Kay sees firms within this model as a pri- vate rather than a public body, which is only defined by the relationship between principal and agent. (Cited in Smerdon, 1998, p7) It is assumed, this behaviour leads in the long-term to remarkable advantages, not only for shareholders but for all other stakeholders as well. It also diminishes the cost of money, either for equity capital as well as for debits. Therefore this behaviour is positive for all. (Witt, 2000, pp159) In the US and Britain, a one-tier board system is used. This means, decision-making and decision-control are often in one hand. For example, in the US the CEO of large corporations is nearly always (93%) the chairman as well. (Monks and Minow, 2001,

Models of Corporate Governance

A corporation in the UK or US is usually headed by a CEO. businessman image by Christopher Hall from Fotolia.com

Corporate governance is the process by which large companies are run. There are various different models that are applied across the world. There is disagreement over which is the best or most effective model as there are different advantages and disadvantages with each model. Methods are developed according to the laws and other factors specific to the country of origin.

1. Anglo-US Modelo The Anglo-US model is based on a system of individual or

institutional shareholders that are outsiders of the corporation. The other key players that make up the three sides of the corporate governance triangle in the Anglo-US model are management and the board of directors. This model is designed to separate the control and ownership of any corporation. Therefore the board of most companies contains both insiders (executive directors) and outsiders (non-executive or independent directors). Traditionally, though, one person holds the position of CEO and chairman of the board of directors. This concentration of power has led many companies to include more outside directors now. The Anglo-US system relies on effective communication between shareholders,

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management and the board with important decisions being put to the vote of the shareholders.

Japanese Model

o The Japanese model involves a high level of ownership by banks and other affiliated companies and "keiretsu," industrial groups linked by trading relationships and cross-shareholding. The key players in the Japanese system are the bank, the keiretsu (both major inside shareholders), management and the government. Outside shareholders have little or no voice and there are few truly independent or outside directors. The board of directors is usually made up entirely of insiders, often the heads of the different divisions of the company. However, remaining on the board of directors is conditional on the company's continuing profits, therefore the bank or keiretsu may remove directors and appoint its own candidates if a company's profits continue to fall. Government is also traditionally influential in the management of corporations through policy and regulations.

German Model

o As in Japan, banks hold long-term stakes in corporations and their representatives serve on boards. However they serve on boards continuously, not just during times of financial difficulty as in Japan. In the German model, there is a two-tiered board system consisting of a management board and a supervisory board. The management board is made up of inside executives of the company and the supervisory board is made up of outsiders such as labor representatives and shareholder representatives. The two boards are completely separate, and the size of the supervisory board is set by law and cannot be changed by the shareholders. Also in the German model, there are voting right restrictions on the shareholders. They can only vote a certain share percentage regardless of their share ownership.

In the U.S. and U.K. corporate governance is concerned with ensuring the firm isrun in the interests of shareholders and its objective is to create wealth for them.Underlying this view of corporate governance is Adam Smith's notion of the invisible hand of the market that he laid out in his seminal book The Wealth of Nations. If firms maximize the wealth of their shareholders and individuals pursue their own interests then the allocation of resources is efficient in the sense that nobody can be made better off without making somebody else worse off. In this view of the world the role of the firm in society is precisely to create wealth for shareholders. This fundamental idea is embodied in the legal framework in the U.S. and U.K. In these countries managers have a fiduciary (i.e. very strong) duty

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to act in the interests of shareholders. Much of research in economics in the more than two centuries since the publication of The Wealth of Nations in 1776 has been concerned with understanding when the invisible hand of the market works and when it does not. The requirements forit to work are strong. These include perfect and complete markets so that there are no transactions costs or other similar frictions. There must be no missing markets or externalities such as those arising from pollution. Everybody must have the same information so that nobody has an unfair advantage over others. Markets must be perfectly competitive. These are strong requirements and are unlikely to hold in most economies. The key question is whether such deviations are sufficient to invalidate the basic insight of the invisible hand of the market. In the U.S. and U.K. it is widely agreed that this is not the case and it is accepted that firms’ objective should be to create wealth for shareholders.2In many other countries there is no such consensus. Japan is perhaps the mostextreme example. Instead of focusing on the narrow view that firms’ should concentrate on creating wealth for their owners, corporate governance has traditionally been concerned with a broader view. One way of articulating this view is that corporate governance is concerned with ensuring that firms are run in such a way that society’s resources are used efficiently by taking into account a range of stakeholders such as employees, suppliers, and customers, in addition to shareholders. With imperfect markets this broad objective can potentially make everybody better off compared to just focusing on the shareholders’ interests (see Allen and Gale, 2000). For example, if there are externalities such as pollution then maximizing the value of the firm is well known to cause a misallocation of resources. If firms were instead to use the broader view above, they would change their behavior and produce the socially optimal level of pollution. In general, although it may not be possible to obtain efficiency it may be possible to achieve a better allocation of resources with the broadview than with the narrow one (see Allen and Gale, 2000, and Allen, 2005). .In countries such as Japan, Germany and France, it is this broad view that is often stressed. Rather than being concerned only with shareholders a wider set of stakeholders including employees and customers as well as shareholders are considered. In fact in Germany the legal system is quite explicit that firms do not have a sole duty to pursue the interests of shareholders. This is the system of codetermination. In large corporations employees have an equal number of seats on the supervisory board of the company which is ultimately responsible for the strategic decisions of the company. In Japan, managers do not have a fiduciary responsibility to shareholders. The legal obligation of directors is such that they may be liable for gross negligence in performance of their duties, includingthe duty to supervise (Scott, 1998). In practice it is widely accepted that they pursue the interests of a variety of stakeholders (see, for example, Allen and Gale, 2000).Examples of Corporate Philosophies in JapanTable 1 contains a typical statement of corporate philosophy for a Japanese firm.

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It is for Asahi Breweries, a well-known Japanese firm. Very little attention is paid to shareholders. In fact they are not even mentioned until Section 6 and then only briefly: “We at Asahi, through securing and expanding the base of our operations, desire to fulfillour responsibilities to stockholders and the local communities in which we operate.”The Japanese company Toyota provides an even stronger illustration of the ideathat if companies pursue the interests of all stakeholders then a superior allocation of resources can be achieved. On August 1, 2001 the Financial Times reported details of the annual meeting of the International Corporate Governance Network which was held in Tokyo that year.“Hiroshi Okuda, chairman of Toyota Motor Corporation and of the JapanFederation of Employers' Associations, told the assembled money managers that it would be irresponsible to run Japanese companies primarily in the interests of shareholders. His manner of doing so left no doubt about the remaining depth of Japanese exceptionalism in corporate governance.…Mr Okuda made his point by telling guests what Japanese junior high schooltextbooks say about corporate social responsibility. Under Japanese company law, they explain, shareholders are the owners of the corporation. But if corporations are run exclusively in the interests of shareholders, the business will be driven to pursue shortterm profit at the expense of employment and spending on research and development.4To be sustainable, children are told, corporations must nurture relationships withstakeholders such as suppliers, employees and the local community. So whatever the legal position, the textbooks declare, the corporation does not belong to its owners. No matter that all the research shows that stock markets respond favourably to higher research and development spending. Nor that the audience consisted chiefly of long-term investors, such as pension funds. The chasm between Japanese and Anglo- American views on what companies are for and whose interests they serve could not have been clearer. "In Japan's case," said Mr Okuda, "it is not enough to serve shareholders."”Despite this focus on all stakeholders, Toyota has done very well for itsshareholders. Figure 1 shows the return from buying stock in Toyota, Ford, General Motors and the S&P 500 index in 1972 and holding this investment with reinvestment of dividends until the end of 2006. Even though it does not focus on the creation of wealth for shareholders, it has done vastly better for its owners than General Motors where this has been the focus. Ford is another interesting example. It is effectively a family owned firm since the Ford family controls about 40% of the voting rights. This concentrated ownership means the owners have strong incentives to oversee management effectively and ensure they create wealth for shareholders. Ford briefly outperformed Toyota in terms of wealth creation in the late 1990’s but this period was very short. Over the longrun, Toyota has again done considerably better.How widespread are these Philosophies?

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Of course, Asahi and Toyota are just two companies. How representative are they of companies in Japan and elsewhere? The view that Japanese corporations have relatively little responsibility towards their shareholders is confirmed in surveys of managers. Figure 2 shows the choices of senior managers at a sample of major5corporations in the five countries, Japan, Germany, France, the U.S., and the U.K., between the following two alternatives:(a) A company exists for the interest of all stakeholders (dark bar).(b) Shareholder interest should be given the first priority (light bar).In Japan the overwhelming response by 97% of those asked was that allstakeholders were important. Only 3% thought shareholders' interests should be put first. Germany and France are more like Japan in that 83% and 78%, respectively, viewed the firm as being for all stakeholders. At the other end of the spectrum, managers in the U.S. and U.K., by majorities of 76% and 71% respectively, stated that shareholders' interests should be given priority.The same survey also asked the managers what their priorities were with regard to dividends and employee layoffs. The specific alternatives they were asked to choose between were:(a) Executives should maintain dividend payments, even if they must lay off a number of employees (dark bar).(b) Executives should maintain stable employment, even if they must reduce dividends (light bar).Figure 3 shows the results. There is again a sharp difference between Japan, Germany and France and the U.S. and U.K.The evidence on managers' views of the role of the firm is upheld by the way thatwages are structured in the different countries. In the U.S. and U.K. wages are based on the nature of the job done. Employees' personal circumstances generally have no effect on their compensation. In Japan and Germany it is common for people to be granted family allowances and special allowances for small children. In France vacation allowances based on family are common. These differences underline the fact that in the U.S. and U.K. the firm is designed to create wealth for shareholders whereas in Japan, Germany and France the firm is a group of people working together for their common benefit.Corporate Governance Differences in PracticeSo far we have argued that the philosophy underlying corporate governance in the U.S. and U.K. differs from that in Japan. We next go on to consider how these differences in philosophy manifest themselves in corporate governance mechanisms.There are five that we shall focus on.(i) The Board of Directors(ii) Executive Compensation(iii) The Managerial Organization of Corporations(iv) The Market for Corporate Control(v) Concentrated Holdings and Monitoring by Financial InstitutionsIn the U.S. and U.K. the board of directors is elected by the shareholders. It

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consists of a mix of outside directors and inside directors who are the top executives in the firm. Once elected the board of directors specifies the business policies to be pursued by the firm. The role of management is to implement the policies determined by the board. Shareholders have very little say beyond electing directors.Except in unusual circumstances, such as a proxy fight, the outside directors arenominated by the incumbent management and thus typically owe their allegiance to the CEO. Table 2 shows the total number of directors and for the U.S., U.K. and Japan (in parentheses) the number of outside directors for a typical sample of large firms in each of the countries. The size of boards is roughly the same in the U.S. and the U.K. and is usually around 10-15 people. In the U.S. a majority are typically from outside the firm while in the U.K. a minority is external.Japan resembles the U.S. in terms of the legal form of corporations because of the heavy influence of the U.S. Occupation Forces on the legal system and the structure of institutions after the Second World War. Some important differences do exist, however. The rights of Japanese shareholders are in theory greater than those of shareholders in the U.S. and U.K. For example, in Japan it is easier for shareholders to directly nominate directors and elect them. Also management remuneration must be decided at general meetings of shareholders.Despite these differences in shareholders' rights, the structure of Japanese boards of directors is such that shareholders do not in fact have much influence. It can be seen from Table 2 that the size of Japanese boards is much larger than in other countries. There are a handful of outside directors but they have very little influence. The overwhelming majority of directors are from inside the company. Their number is such that they include many people in addition to the most senior members of management. The nominations of individuals for positions as a director are essentially controlled by the company's CEO. This together with the unwieldy size of the board and its composition means CEOs hold tremendous power. Provided the financial position of a Japanesecorporation is sound it is essentially the CEO and those closest to him who control the company's affairs. The structure of many Japanese companies’ boards has changed in recent years. In response to the forces of globalization a number of firms have reformed their boards to reduce their size and bring them more in line with U.S. and U.K. boards. One of the most important corporate governance mechanisms is the structure of senior executives’ compensation. Provided investors have an incentive to gather information and stock market prices partially reflect this, incentives can be provided by making managers' compensation depend on the company's stock price. Examples of theform which this dependence can take are direct ownership of shares, stock options and bonuses dependent on share price. Provided stock prices contain enough information about the anticipated future profitability of the firm fairly effective automatic incentive systems to ensure managers maximize shareholder wealth can in theory be designed. In addition to stock prices accounting based performance measures are also frequently used. The advantage of stock prices is that they cannot be as easily manipulated by management as accounting data.Another motivating force for managers is the possibility of dismissal for bad

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performance. If other firms perceive that the performance was due to incompetence the manager may find it difficult to find another job and so may bear a large penalty. On the other hand, managers who perform extremely well may be bid away at highercompensation levels to other companies. The managerial labor market thus also plays an important part in providing incentives to managers.One of the most important differences between the U.S. and other countries is the level and structure of executive compensation. Executives in the U.S. are paid much more on average and a greater proportion of their compensation is performance related. This is true even relative to the U.K. and particularly relative to Japan. Senior executives in Japan are among the lowest paid in the world and relatively little is tied to the stock price of the company (see, for example, Figure 12.1 in Brealey, Myers, and Allen, 2006). Although there has been an enormous amount of effort devoted to understanding the operation of the U.S. and U.K. system where firms pursue shareholders' interests, or Anglo-American capitalism as we shall call it, there has been relatively little devoted to stakeholder capitalism where firms pursue the interests of a variety of stakeholders.However, to the extent that there is such a literature it mainly focuses on the managerial organization of corporations. Aoki and his co-authors have made great progress in understanding the main differences between Japanese and U.S. firms. Aoki (1990) contains an excellent survey of this literature. He contrasts the traditional U.S. hierarchical firm, the "H-mode", with the Japanese firm structure, the "J-mode". The Hmode is characterized by (i) hierarchical separation between planning and implementaloperation and (ii) an emphasis on economies of specialization. The J-mode stresses (i) horizontal coordination among operating units based on (ii) the sharing of ex post on-site information. It is suggested that among other things "lifetime employment", "seniority advancement" and management discipline through competition over ranking by corporate profits are important. Also the fact that management decisions of Japanese corporations are subject to the influence of employees as well as owners is stressed. Aoki stresses that the structure of corporations’ organization has an important influence on the efficient useof its resources. In the U.S. and U.K. it is widely argued that an active market for corporate control is essential for the efficient operation of capitalist economies. It allows able management teams to gain control of large amounts of resources in a small amount of time. Inefficient managers are removed and replaced with people who are better able to do the job. The existence of a market for corporate control also provides one means of disciplining managers. If a firm is pursuing policies which do not maximize shareholders' wealth it can be taken over and the managers replaced. There are three ways in which the market for corporate control can operate. These are proxy contests, friendly mergers and hostile takeovers. Proxy contests involve a group of shareholders trying to persuade the remaining shareholders to act in concert with them and unseat the existing board of directors. For example, if somebody wishes to change a firm's policies, one way that she can do it is to have her and others with similar views voted onto the board of directors at a shareholders meeting. In order to do this she solicits

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proxies from other shareholders which allows her to vote their shares. Proxy fights are usually difficult to win because holdings are often spread among many people. As a result they do not occur very frequently in most countries.Friendly mergers occur when both firms agree that combining them would bevalue creating. In this case there are a number of ways that the transaction can occur. There may be an exchange of stock or one firm may make a tender offer for the other firm's stock. Friendly mergers and takeovers occur in all the countries under consideration and account for most of the transaction volume that occurs. The third way in which the market for corporate control can operate is through hostile takeovers. These occur when there is conflict between the acquirors and acquirees over the price that should be paid, the effectiveness of the policies that will be implemented and so forth. Hostile tender offers allow the acquirors to go over the heads of the target management and appeal directly to their shareholders. This mechanism is potentially very important in ensuring an efficient allocation of resources. A very significant difference between U.S. and U.K. on the one hand Japan on the other is that hostile takeovers are almost unheard of in Japan whereas they are common in the U.S. and U.K. Historically, cross-shareholdings were put in place by many Japanese companies to prevent hostile takeovers. Although these cross-shareholdings have been reduced significantly in recent years, they remain a formidable barrier. The recent casewhere Oji Paper, Japan’s largest paper company, attempted to take over Hokuetsu Paper, illustrates other difficulties (see The Economist, September 7, 2006). The Japanese paper industry had significant overcapacity. Oji Paper felt that industry rationalization would best be served if it acquired Hokuetsu with its new plants rather than build its own new plants. However, Hokuetsu feared the impact of such a takeover on its stakeholders and with the help of the industry number two, Nippon Paper, fended off the bid. The importance of equity ownership by financial institutions in Japan and Germany, and the lack of a market for corporate control in these countries have led to thesuggestion that the agency problem in these countries is solved by financial institutions acting as outside monitors for large corporations. In Japan, this system of monitoring is known as the main bank system. The characteristics of this system are the long-term relationship between a bank and its client firm, the holding of both debt and equity by the bank, and the active intervention of the bank should its client become financially distressed. It has been widely argued that this main bank relationship ensures the bank acts as delegated monitor and helps to overcome the agency problem between managers and the firm. However, the empirical evidence on the effectiveness of the main banksystem is mixed (see, for example, Hoshi, Kashyap and Scharfstein, 1991, and Aoki and Patrick, 1994). Overall, the main bank system appears important in times of financial distress, but less important when a firm is doing well.This review of the five mechanisms of corporate governance and their operationin the U.S. and U.K. compared to Japan shows how fundamentally different the two systems are. Not only do the philosophies underlying the two systems differ but their means of implementation are also very different.Conclusions

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For countries such as China that are reforming their corporate governancesystems, the Anglo-American model provided by the U.S. and U.K. provides onepossible direction to go in. These countries’ corporate governance systems are based ona narrow view of the role of the corporation in the economy. This is that firms’ focus should be on creating wealth for shareholders. This system can lead to an efficient allocation of resources provided, among other things, that markets and institutions are well developed and competitive. However, the Anglo-American model is not the only one. In many countries, and particularly in Japan, a broader view of corporate governance is taken. This requires that companies use resources efficiently by taking the interests of a range of stakeholders, notjust shareholders, into account. In cases where markets and institutions are not perfect and competitive this view of corporate governance can lead to a superior allocation of resources than the narrow view.

india

Issues of corporate governance have been hotly debated in the United States and Europe over the last decade or two. In India, these issues have come to the fore only in the last couple of years. Naturally, the debate in India has drawn heavily on the British and American literature on corporate governance. There has been a tendency to focus on the same issues and proffer the same solutions. For example, the corporate governance code proposed by the Confederation of Indian Industry (Bajaj, 1997) is modelled on the lines of the CadburyCommittee (Cadbury, 1992) in the United Kingdom. This paper argues however that the crucial issues in Indian corporate governance are very different from those in the US or the UK. Consequently, the corporate governance problems in India require very different solutions at this stage of our corporate development.The corporate governance literature in the US and the UK focuses on the role of the Board as a bridge between the owners and the management (see for example; Cadbury, 1992; Salmon,1993; Ward, 1997). In an environment in which ownership and management have become widely separated, the owners are unable to exercise effective control over the management or the Board. The management becomes self perpetuating and the composition of the Board itselfis largely influenced by the likes and dislikes of the Chief Executive Officer (CEO). Corporate governance reforms in the US and UK have focused on making the Board independent of the CEO. Many companies have set up a Nominations Committee of the Board to enable the Board to recruit independent and talented members. There is now increased recognition of therole that the Board could play in providing a strategic vision to the company. TheCompensation Committee of the Board has been strengthened to exercise greater control over CEO compensation following widespread complaints that top management pay is disproportionate to performance. There is also a great deal of discussion in the literature on the role of the Board in firing non performing management and in managing the CEO succession. Perhaps the most powerful

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and well established of the Board committees is the Audit Committee. Apart from acting as a deterrent against financial improprieties and frauds,the Audit Committee also enables the Board to keep a pulse on the financial health of thecompany. Turning to the Indian scene, one finds increasing concern about improving the performance of the Board. This is doubtless an important issue, but a close analysis of the ground reality in India would force one to conclude that the Board is not really central to the corporate governance malaise in India. As elaborated at length in this paper, the central problem in Indian corporate governance is not a conflict between management and owners as in the USand the UK, but a conflict between the dominant shareholders and the minority shareholders. The Board cannot even in theory resolve this conflict. One can in principle visualize an effective Board which can discipline the management. At least in theory, managementexercises only such powers as are delegated to it by the Board. But, how can one, even in theory, envisage a Board that can discipline the dominant shareholders from whom the Board derives all its powers? Some of the most glaring abuses of corporate governance in India have been defended on the principle of “shareholder democracy” since they have been sanctioned byresolutions of the general body of shareholders. The Board is indeed powerless to prevent such abuses. It is indeed self evident that the remedies against these abuses can lie only outside the company itself.It is useful at this point to take a closer look at corporate governance abuses by dominant shareholders in India. The problem of the dominant shareholder arises in three large categories of Indian companies. First are the public sector units (PSUs) where the government is the dominant (in fact, majority) shareholder and the general public holds a minority stake (often as little as 20%). Second are the multi national companies (MNCs) where the foreign parent is the dominant (in most cases, majority) shareholder. Third are the Indian business groupswhere the promoters (together with their friends and relatives) are the dominant shareholders with large minority stakes, government owned financial institutions hold a comparable stake, and the balance is held by the general public. The governance problems posed by the dominantshareholders in these three categories of companies are slightly different.

The Ethics of Governance

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When we have a set of principles, of values, which we have been learning for many years, we organize our life following this structure, and then we try to apply that frame of mind to practical situations in our life. But often, we find ourselves in a sort of uncomfortable position because the moment we try to apply our values to this very present practical issue, we feel that the situation is not as clear as we would like, that we can not tell very clearly which is the best possible alternative.

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Often, it is not a choice between good answers and bad answers, good and evil, but maybe between two good things or two bad things. We would like to be much surer about our decisions.

When this happens in government, it is even worse because the whole society will be affected by your decision. You are not dealing with your own life. You are dealing with many millions of lives at the same time. Maybe things will never be the same again in the future because of your decision. So, ethical decisions in government are: How do you apply your theoretical values to practical decisions where you do not have pure answers and when the whole life of your society or community will be affected?

I have found a lot of really important information at the Web site of the Markkula Center. You have very good practical advice and tips on how to deal with these problems. The first is to get the facts. For example, when you have a headache, probably, the headache is not the problem; the headache is the symptom of the problem. If you hit your head against the wall, that's Scenario A. If you have a hangover, that's Scenario B. If you have a tumor in your brain, that is Scenario C. So, to have a headache is just a symptom of something else. What you need to do if you have the symptom or a group of symptoms is to try to sort them out, to elaborate possible explanations for them—that is how doctors proceed. For each possible explanation, you can have an action plan and then you have to implement it. So you go from practical things—the headache—to theoretical things—the possible diagnosis—then to the possible solutions—the prescription—and then back to the practical field—the treatment or the implementation of the cure.

You have more or less the same system dealing with the problems in government. You need the facts. The facts can be the symptoms or the problem. You never know at the moment you start analyzing the problem. So, you get the facts, and then you try to make some sense of them. You have some theories or hypothesis of what is causing the symptoms. And then you try to implement the course of action.

You also have to deal with the problem in ethical terms. The ethical approach is the Utilitarian. You have to balance how much good and how much evil you produce with your actions. If the good outweighs the evil, you should do it, as it is a sort of balance. The second is based on the concept of rights. There are some basic human rights that you have to respect. You are not allowed to affect those human rights in order to produce good in your society. The third one is based on the concept of justice or fairness. We have at least three different concepts about justice. You can have distributive justice in which you try to distribute all the goods of the society according to the needs of the people. But you can also have the concept of contribution. In this case you are not receiving on the basis of what you need but on the basis of what you are contributing to society. And then you have the compensation concept. In this case you have the right to be

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compensated if you have losses or harm done due to others. The fourth major ethical approach is based on virtues. The question is not what I should do, but what kind of society would I like to have in the future. How are my actions going to contribute to that future? And then you have the common good, the concept in which you are doing things that are equally good for everybody in your community.

Now I want to invite you to think about how to apply these approaches to three different scenarios that were real and practical in the life of Latin American presidents in the last five years. In January 2000, five years ago, I was President of Ecuador. My country had faced the worst economic crisis of the century. Everything that could go wrong went wrong. We were exporting oil. Oil represents 50 percent of the exports of the country. (This changes every year, but to give you the magnitude we dealt with). Fifty percent of the income of the state is coming from oil. And, oil prices in '98 went down to $7 per barrel. The legislature that approved the budget of the country had estimated that the price would be $14 per barrel. This means that when the price went down to $7, you had only enough money to pay salaries for half of the year, not the whole year. The people who didn't get paid—public servants, teachers of public schools, doctors, nurses, police—started striking and protesting. The moment the police had to control the protesters in the street, they knew that the teachers were representing their problems because the police were not paid either. We had a big problem.

On top of that, we were leaving the worst El Nino in the last 500 years. We lost 16 points of GNP due to the flooding. All of our exports were affected by that. At the same time we had a big financial crisis in the country. The financial sector was doomed to fail. We had the Asian crisis, in Russia and Brazil. Things were absolutely complicated. As a consequence, after many months, the people were very angry; the popularity of my government was very low. The people were tired of waiting for solutions that we couldn't provide, fed up with public declarations from the main voice of the economy of the country.

The economic advisors would say what we should do but nothing was implemented. So, the people decided that the time had come for change in the government and organized a big movement—coming from the rural sector to the city - sitting, refusing to move until the president, the vice president resign and the Supreme Court and congress resign. After the resignations, an implementation of a popular government would occur. The people would appoint the new government, congress, and Supreme Court. This was the time of real change in Ecuador. One morning I received a visit from the Joint Chiefs of Staff in the armed forces. They said that they thought that the situation in the country was so difficult, that I should give my resignation to allow a constitutional solution to the crisis. So, you are the president of Ecuador at that moment. Should you resign or not? And what is the criterion for knowing what is best?

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I myself decided not to resign. I actually said, if you want to produce a coup d'etat, you are free to do it. I can do nothing to oppose that. Coup d'etat is based on force and I do not have the force. But, I think that my resignation would contribute to that and I am not going to contribute to this obvious break in the constitution of our country that will affect all the institutions in the country. One year and one half after that, President Fernando De La Rua, the president of Argentina faced the same problem. He was in his presidential palace in Buenos Aires, and he was surrounded by civic organizations and movements. The ministers of the cabinet couldn't come to the presidential palace to meet with the president because the access was impossible. There was looting in small businesses, and the owners of the business had begun to shoot to protect their property. The list of people killed was increasing. The president would not resign. Last year, President Gonzalo Sanchez de Lozada, president of Bolivia, faced a similar situation. After many months of a disappointed population, he faced a big crisis. The people thought the government was failing and should be replaced. He could have overcome that, but he had another crisis simultaneously. The opposition in the congress and military asked for his resignation. He refused to resign. In the city of La Paz, it is easy to block the street, preventing the flow of everything. The people blocked the streets of La Paz. There was no food in grocery stores. The situation had become increasing violent. The police and military were killing people while trying to produce order in the streets. And still the president refused to resign, to leave his country during such chaos.

At the end of the day, I didn't resign. I had three or four more attempts made for me to resign. I refused to resign. Congress decided to interpret that as I left the presidential palace, even though I was still in Quito, I had abandoned power. The vice president was given the reins of the country. We actually had four governments in one day. No one could consolidate power that day. At the end, they invited the vice president to take over as president. Thank God no one was wounded or shot; it was a very peaceful movement. In Buenos Aires, Fernando de la Rua did resign. As the vice president of Argentina had resigned before he did, Argentina had four or five governments in two weeks. No one was able to consolidate power in the country. De la Rua left in a helicopter, but stayed in Argentina. I stayed in Ecuador. In Bolivia, President Sanchez resigned, and he came to Washington, where he lives now.

What was the right thing to do in the situation? Should you resign or not? We did not have the time, the tranquility, or the confidence that the information we received was accurate or complete—we learned many things by watching TV—and, we had to act. This is a clear dilemma—the dilemma of acting with responsibility when invited to resign. At this point, you must analyze at least two things: the concept of legality and the concept of legitimacy. You are the legal president. You were elected. In the case of Ecuador, I won by 36 percent of the vote, first round and 2.5 million votes and we have 10 thousand people in the streets protesting against the government. Of course, those 10 thousand were representing a big majority in the country. They were against the president, but

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they did not want the resignation of the president or a change in government that would be too chaotic for their country. They simply did not like the way the president was governing. So you can be a legal president, but how do you measure the legitimacy of your mandate? Is legitimacy something that you must earn each week through your actions or is something that you gain once. And how do you measure legitimacy. The moment you become unpopular, are you illegitimate? Many presidents in Latin America have made many tough and unpopular decisions. They have seen their popularity dipping down, and after one or two years, the economy recovered and they were re-elected. So at which moment in time, which point in time is the evaluation of the legitimacy of the president to occur? It is unclear. And at what moment do you make the decision to resign or not? In the first minute when you are asked? Do you have to wait and see? If waiting means that you will have 10, 20, 30 or more people killed in the streets, you must ask yourself how you are contributing to the peace of the country. You must evaluate such a decision every single minute. It is not an easy answer.

I'd like to move to the second dilemma. We the presidents of conflicted countries with problems of poverty and inequality are only saying what a good father says in a family: "I am doing this for your own good." Who is going to buy that? That's a big question mark! But we truly believe in that thought. We put ourselves in danger. We affect our popularity, our political capital, because we think that is the best solution for the country. We think we have a long-term perspective. We are not thinking of the next election but the future of our country. The difference between a politician and a statesman is the perspective you have. The people of Latin America are very skeptical and increasingly cynical. The main problem is usually an economic problem as we run big fiscal deficits. It is healthy for the economy to have no deficits or at least to have control of all deficits. How do you balance the budget? You increase your revenues or you cut your expenditures. There is no other way, no magic here. What are the expenditures of the government? Well, mostly, social programs. You must cut social programs when you must cut expenditures. You must cut subsidies, yet you were elected for increasing subsidies. Your people want a better standard of living, but you must increase the price of gasoline. Every president does that. It is not because we are inhuman or stupid but because we do not have the alternatives. To not cut subsidies would be worse. So, we make these type of decisions although the people say they disagree.

I invited a great friend and economist to come to Quito, and he met with leaders of the country to explain how important it was for the country to gain control of the fiscal deficit, how this would change the image of Ecuador in the eyes of the international community; how it would allow Ecuador to get a program with IMF; how we would get investment and loans from banks; how, with this investment we could build more factories; how, with these factories, we would create more jobs; how with these jobs, the economy would grow; and how this would be good for everybody.

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While he was talking with this group of indigenous people, there was a very poor woman there, with a crying child in her arms. When he finished, she said: "Look, Mister, you have come from the United States to tell us what the president says every day. I voted for this president because I thought he was going to be different. But, he is doing exactly the same things that the former presidents have done. He betrayed us. We thought he could be more human, that he would take care of us. But he is like anybody else. You are saying that if we accept an increase in the price of gasoline, that will increase every thing in the country because the multiplying of that effect will affect everything—food, rent, transportation, everything. And you are asking us to accept this increase in gas prices because if we do that, maybe after four or five years, somebody in the developed world, who thinks that this is a serious country, stable, with a responsibly managed economy, will put a factory here. My husband, who has been unemployed for five years, will have a change to get a job. I just came from the hospital. This child is crying because he is sick. The hospital does not have medicine, and I do not have the money to buy the medicine. So you ask me to accept this present pain for this hypothetical future? No, Mister. I prefer to suffer the problems I am suffering now and to not increase them, hoping that something will change in the future."

She is right. How can you or I guarantee that if we do this, we can provide the people with a better future? We have been saying the same thing for 20 years in this country with every single government. So what is the dilemma here? We can call this a sort of inter-temporal tradeoff. We can agree very easily that we cannot sacrifice the future for present gains. We cannot cut all the trees in the country to make money because we would be affecting our future. So, do not affect the future for the present. But would you compromise the present for the future? Is it not the same sort of reasoning? I understand: No pain, no gain. But, you can have a lot of pain with no gain. So, having pain is not a guarantee of gain in the future. What should you do? What is the right ethical decision here?

I read a great article written during World War II by a priest here in the United States. He was criticizing the bombing of the German cities in Europe by the English Air Force. He was saying that you cannot use the present, to destroy as much as possible, to shorten the period of the war. Ethically speaking, how can you make those sort of real sacrifices for a hypothetical future? When I read that about producing an actual bad thing in the hopes that the future would be better, I thought, that is exactly what we are doing with adjustment programs in Latin America every day.

The third point is related to the second. The Bible says that you cannot serve two masters at the same time. Let's say your people are asking you to do A, and your people are your master because they voted for you—you couldn't be the president without their support. Your legality and legitimacy are based on them, and they are asking you to increase the fiscal deficit. On the other hand, in this globalized era, we must be connected with the international community. If you do

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not play by the rules of the international community, you are absolutely out of the loop, a pariah in the international market, and you will never get a cent. All the hopes for your country to develop are affected. What do you do? Do you say, "I am their president. I must do this?" If you do that, you know you will die of asphyxia because you will never get a cent from abroad and you don't have a capacity of savings in your country. Or will you say, I will play by the rules of the international financial community? In that case, your people are very angry with you, overthrow you because they don't like what you are doing.

What is your role as president—the core question? If you are president, are you an agent of your people, so you have a mandate and you can only do what they have decided for you to do—you do not have the capacity to act beyond your instructions? Or, are you not an agent but a decision maker? You have the right, the obligation, and responsibility of making your own informed decisions with your own set of values. If you do the second, the question you must answer is: Were you elected president or emperor? Who do you think you are? No one in this country wants an increase in the price of gasoline. From an ethical point of view, where does your authority come from for going against the will of the people. You can say, Vox populi, vox Dei—the voice of the people is the voice of God—but this could be a very easy way out, like Pilate washing his hands. "I don't find a fault in this man, Jesus, but as you say he is guilty, and this is your responsibility. I wash my hands."

Or this is this the real ethical solution? I cannot do more than this because I am not deciding about my life; I am deciding about the future of the country. Why should I assume that I know better than 12 million people? Are they absolutely wrong because they are not educated, because they didn't get college degrees? Or should you say, forget about college degrees. They are 12 million, and they are the rulers of this country if this country is a democracy. If you do the second, can you make decisions? And if you make the decisions of the people against your own conscience, what are you doing? Should you resign? Should you stay there and do your own will? As you can see, those are real ethical dilemmas. I am not talking about political advantage, whether it is good or bad in electoral terms; I don't want to touch that. Just from an ethical point of view, what is the right thing to do?

If you have 70 percent of your country saying, "We want a modern country. We want changes," and you have 30 percent of the population saying, "We oppose that. We don't want that," what would you say? Would you say, "This is a democracy and that means the majority rules, so we will do what the 70 percent want, and you 30 percent align with the 70 percent; otherwise I will use the legitimate force of the government for forcing you to accept this decision." (Assuming that you can do that, this is a very big assumption). Or, would you say, "This is a democracy. Democracy is about respecting the rights of the minority, and 30 percent is a big minority. Who am I to tell you what you should think and believe? I don't have that right. Now, if you are boycotting this 70

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percent preference, you will produce a gridlock here, and this is very bad for the country. I don't like it, but I don't have the right to impose on you this will of the 70 percent. I have to respect you." What is the ethical thing to do?

A final note: The Markkula Center is concerned about applied ethics. You can take many classes about ethics, but you have to apply it to your real life. That is the point. Once Mahatma Gandhi said, "When I am cremated after dying, you should cremate with me all the books I have written." But why? "Because if I couldn't convey with my life the message I want to transmit, what is the importance of my writings? It is my example that really counts." We have to watch our deals and our actions but not rush to judge. We are so prone to find faults in others. We are find finger pointing so easy. Every time you are pointing a finger at someone, you have one finger pointing at that person and three pointing to you. Don't rush to judge others. Who are you? Who do you think you are? Are you sure that you have all the facts and that you really understand the case? Are you sure that you are making a final objective appraisal of the situation? Can you judge the consciousness of other people? How can you do that? Who knows that?

There is no recipe book. Sorry. Bad news. There is no recipe book. We have some very basic universal principles. Don't kill others. Yes, everybody agrees with that. We have some other general principles. But we sometimes have difficulty applying these principles to real situations. Another point: Prepare in advance. Prepare your framework, your values. Analyze them. Try to clarify them now at the university. You have the right setting: You have professors, books, time, tranquility. In a moment of crisis, you don't have the atmosphere for doing that. If in the moment of crisis, you try to discover what your values are, you will be in a really difficult situation. The crisis tests your values. This is the moment to test your faith in your values, not the real moment to discover them.

Two final comments: First, the only person you will be with forever is yourself. At the end of the day, at the end of your life, the only person that will be with you for sure is yourself. So get a good relationship with yourself. Second, all the decisions in your life, at the very end, force you to choose between two things: to sleep well or to eat well. I think it is better to chose always to sleep well. If on top of that, you can eat well, thank God. Thank you very much.

Q: Talking about the two masters —with your global economy on one side and your people on the other, how difficult is it ethically and as a leader to balance the two to a positive end.

A: There are some things that they have in common. You could argue for example that in the long term, both masters are asking for the same thing: a stable economy, a good future. But, in the short term they are not. You can accept without a problem that a balanced budget is good for the country, but many other things that the international community asks of you as a leader are

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very whimsical. Some of them do not make sense for third world countries. Let me give you one example. What happens in the US when you have a decrease in the GNP in the growth of the economy? Usually the government says, we have to reduce taxes. You can have a big debate on the system you will use to reduce taxes. You can say the system favors rich people or not-that is a legitimate debate, but I will not enter into that. But the idea of reducing taxes, of leaving more money in the hands of the people to increase demand and so forth, could be a rational one. The moment the president of a developed country does that, he seems to be intelligent, concerned about his people, and making good decisions. If you are in a third world country with exactly the same situation, you have to do the opposite. Why? In the moment of a crisis, your fiscal deficit will increase, and you have to reduce it because of the ghost of inflation. The cost of losing international support is even greater than the cost of increasing taxes. So you have to do it. But, can you imagine how you can sell to your people? At the moment they are worse off than ever, you have the good news that they will pay more taxes? So you seem a bit stupid and lack of sensitivity to problems, living in the sky, not on earth, that sort of thing. So, it is very difficult to balance in moment of extreme crisis. You have to choose and choosing always puts the other half of the people and institutions against you. In good times you can juggle a little with both.

Q: Which western corporations control the oil in Ecuador? And why won't the country take back control of its own oil?

A: The situation in Ecuador is different. In Ecuador, the oil is the property of the state, not of private owners. The state has basically two different ways to deal with it. We have a national corporation that handles lots of wells and production of oil, accused always of incompetence and ineffectiveness and corruption. And, in some other sectors of the economy, we have contracted with international companies. Why? Because the capacity of the country for developing all the wells alone is not there, so we need some sort of international capital there. Second, we get some advantages with that. We can exploit the oil and export it, which is an income, and at the same time, we can have fees or taxes. So, how do you balance the national property and the international is one question. What is the best possible development is another, and we have been debating that in Ecuador for 20 years. Every time somebody tries to privatize any economic sector in the economy—Ecuador is one of the countries lagging in any type of privatization effort—you have the congress with very important voices blocking it. We are in the same position for many years.

Q: Which concrete steps did you take to eradicate corruption while you were in power?

A: Two days before I started as president, I received a telephone call from President Jimmy Carter, saying that the Carter Center in Atlanta had been following my career as the mayor of Quito and had decided to propose that I

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accept the recommendations and conclusions they had arrived at after analyzing cases of corruption in the whole world. I told him I was very honored by the call. I invited him to come to Quito; he came with his wife Rosalyn, and we developed a project understanding one basic thing: that the fight against corruption is a national effort; it can not be only the task of the government. You need the whole society working in that purpose—the executive branch, the legislative branch, the judiciary, the civil society, the press—you need to mobilize the country. Otherwise you will be so lonely in your fight that you will not succeed. We started working on that. I have two personal comments. First, this is a very widespread problem in the world. My humble understanding is that what we call corruption, in Latin America—the same conduct, I have seen described here as lobbying. Sometimes it is the way you name it. Second, the big cases of corruption are about big bribes in big contracts because the smaller ones are irrelevant to the country. Big contracts are about big projects and you have international bidding with big international companies. So in the case of corruption, always, somebody from the private sector is paying the bribe. And you can say that this country is corrupt because the government of this country is trying to get money or you can say the opposite. How can you keep your government clean, if your civil servants, who are earning very low salaries, are being tempted and offered every single day some sort of rapid change in their lives? Third, more generally, esteem the values of the society; otherwise the society will go in a different direction. If every night you turn on the TV and watch every commercial, what is the message there? You will be happy if you have money. You will get the best car, the best watch, the best whiskey, the best plane. When you have money, everybody is smiling. You can have the best steaks and go to the best places. So the message is, you must get money to be happy, which is absolutely wrong. We have a writer in Uruguay, Eduardo Galeano—very ironic. He says he knows that money doesn't buy happiness, but it buys something so similar that the difference is for experts. So if we send this message to people every day, to captive audiences that do not exercise their critical faculties, but are passive, where in countries the opportunity for having a job doesn't exist, you are putting them between a rock and a hard place. If we don't we have an international crusade in that sense, I don't see change. I don't see that type crusade going on. We are very good at making speeches about corruption, but in practical terms, almost nothing is done.

Q: What ethical dilemmas did you face in negotiating the peace agreement with Peru? How do you think the agreement, especially the bi-national development plan, has been implemented since you had to leave office?

A: It was an interesting case because it is difficult to find a cause in which everyone agrees during a peace process. Who can be against peace? You have to be almost mentally ill to say, "I don't like peace." So the problem is never peace itself; it is the conditions or the framework in which the peace is inserted. We had an imminent war with Peru the moment I started my presidency. Actually, both countries were claiming as part of our national sovereign territory,

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the same piece of land. Three or four hundred years ago, South America must have been about three times the size it is now, if you have to give credence to every claim that arises today. But the situation was very painful with Peru and Ecuador—two hundred years of problems. It started with the discovery of the Amazon River. We, the Ecuadorians, were saying, the expedition that discovered the Amazon River, not a small feat, departed from Quito, and the laws of the time, decided that this belonged to the royals of Quito. How can you Peruvians deny this fact? Well, Peruvians never denied that. They only said that during that time, the royals of Quito were part of the vice royalty of Lima, so the discovery was following orders from Mr. Pizarro of Lima. Yes, you did it, but you were not autonomous, so it is Lima's.

When I took office, the problem was reduced to a small place called Tiwintza, which has the same value that the Alamo had for Mexico and the United States. It was a symbol of identity. Peruvian soldiers died and were buried there. Every thing else was agreed by national projects, trade agreements, and beautiful declarations about the future. But, who will get Tiwintza? Will Tiwintza be on one side of the frontier (Ecuador), or the other (Peru)? The congress of the country that does not get the land, will never approve the treaty. According to national law, the treaty needs the approval congress. That was a dead-end situation. With all the problems I have described in Ecuador, having a war on top of that would be unbelievable. We found a solution, which was a creative one. We separated two concepts that usually come together: the concept of property and the concept of sovereignty. So at the end, the solution was to declare that Tiwintza was part of the sovereign territory of Peru but that Ecuador would have the permanent property of that territory. Both countries saved face and could claim they had Tiwintza. That was a good solution because no one was happy, but no one felt cheated or abused. Peru has always felt abused because we are small, but for the first time we had a treaty that was not imposed either by Peru or international players. Both congresses signed a blank check, voting at the same time. The legislators in Lima with radio transistors listened to the congress in Ecuador. And in Ecuador, it was the same with Lima. No one wanted to vote before the other. At 4 in the morning, both decided to vote and both signed blank checks. I still cannot believe what we did.

Q: Can you speak about the American free trade agreement and how the lack of labor, environmental, and healthcare standards will affect Ecuador if it's passed?

A: Maybe we can construct another dilemma here. You have a people that have no jobs, and they can have opportunities with the new factories. At the same time, they are not receiving as good treatment as other countries. So, it is unfair for them. What is worse, not having a job or having a job in very difficult circumstances? You must choose between the two. Free trade agreements are good in my view. But, it would be a little naïve to think they will change the world because in every single trade, everybody will try to keep the situation as it is now. I like to use the analogy of poker. If you are playing poker, and you have the four

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aces, would you like to reshuffle the cards? No! And, in this stage of the globalization process, I think that all the developments are going to the developed world. In exchange, we are hoping that changes will come in the future to the under-developed world. Is that going to happen?

Transparency and Accountability in Governance and Right toInformation in IndiaIntroductionIn the six decades of independence from alien rule, India, despite its burgeoningpopulation, grinding poverty, large-scale illiteracy and unparalleled diversity, has not only remained successfully afloat in the democratic ark, remarkably so in adestabilizing neighborhood, but can also rightfully boast of significant advances made in agriculture and food production, science and technology, trained technical man power and higher education to name a few areas of success.While these are the positive developments, there are other areas where India islagging as a nation. Still considered as a developing country, India ranks 132 out of 175 countries according to the UNDP's human development index (HDI). When it comes to competitiveness on the global economic front, according to the world competitiveness Index it ranks 58th out of 53 countries. And when it comes to corruption, India's record is rather dismal as it is ranked 66th out of 85 in the corruption perception Index by the German NGO Transparency International, which arranges nations in the order of perception of corruption in the country.1 Needless to mention, the above three indices have a direct bearing on governance.Governance DiscoursesEtymologically and semantically, words like 'governance' and 'goodgovernance' seem to belong to the same genus as very ancient terms like 'state' and 'government'. In fact right from the recognition of the concept of government, either for the community or for the nation state, value premises have been developed as to how a government has to perform and how not to function. Thinkers and theorists have pondered upon the concept continuously. 'Good governance' was traditionally related to resource management. It has been a subject in the political discourse right from Socrates to Mahatma Gandhi. Ancient literature provides ample evidence for the establishment of 'good governance'.Yet, there was no such intense discussion on this concept earlier. In fact it hasgained currency only in the last two to three decades as a descriptive label for some parts of the policy packages associated with the 'conditionalities' of donor agencies viz. IBRD, IMF, WB who have lent loans for development works etc. in the Third World. The lending experiences in many developing countries soon brought home the realization that, despite technical soundness, development programmes and projects, loans financed by them often failed to produce desired results given the extreme diversity of the political culture and administrative structures prevalent in most of the Third World countries. Often, it was felt that the laws were not enforced properly. In the absence of proper accounting, budgetary policies were not efficiently monitored. All this obviously encouraged

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corruption and lead to distortion of investment priorities. Operating on commercial principles of supporting 'bankable' projects, the WorldBank etc. were compelled to adopt prudential policies and devise new conditionalities to ensure proper utilization of its loans. Thus was born the concept of 'good governance' which became a critical component for determining a loan recipients' capacity forsuccessful implementation of carefully planned World Bank loan assisted projects. Thus the World Bank and later the OCED identified significant list of 'good governance' dimensions which entail explicitly or implicitly, reduction or curtailment of the existing functions traditionally being performed by various governments. As per the World Bank definition 1992 the basic function of governments should be 'management of country's economic and social resources for development'. It would be pertinent to highlight the fact that while the Constitution of India casts a wide array of welfare and regulatory functions upon the union and state governments, the World Bank governance discourse focuses on 'developmental function' with narrow economist and technicist dimensions, more in tune to its agenda of maintaining its supply of loans with assured payback prospects.Paradigm shiftParadoxically, this donor driven exercise, to reform government andadministration has successfully elicited strong-willed responses from recipientcountries, to the extent that academic and administrative analysts have been vying with each other in highlighting the pathologies afflicting the politico-administrative system.On the other hand, it cannot be denied that the success story of command economies was critical in determining the 'interventionist' role of state in India in the early decades of post independence. In keeping with the spirit of the times, India adopted the 'prescriptive planning' process. But unfortunately, the controlled economic system was widely abused and infused with rampant corruption, inordinate delays and inefficiency. The ominous result was a serious 'balance of payment crisis' owing to a steady decline in exports, negative growth rates in industry and agriculture, decline in domestic productivity, inadequate returns and continuing losses from massive investments in public sector enterprises and economic populism resulting in increasing state subsidies, especially in fertilizers, and hidden payments incurred though lower tariff rates of public sector enterprises in power and transport sectors. Understandably,the need for change was inevitable. Consequently the endeavours to 're-invent' government in accordance with the World Bank agenda of 'good governance' included dismantling of its regulatory mechanisms, disinvestment of its mammoth public sector enterprises and withdrawal from all business activities. This also implied adoption of a new market-driven package of economic policies popularly known as Liberalization, Privatization, Globalization (LPG) reforms.To operationalize the above in consonance with good governance, 'new publicmanagement' has been considered a vital input. The past couple of decades have witnessed a great deal of structural adjustments, limiting of the role of state,downsizing of bureaucracy, devolution of authority, cost reduction, contracting out some of the operative functions of the government, developing and designing

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result oriented appraisal systems and commercialization as well as market orientation of governmental activities. This has been supported by effective accountability through an open reporting system. The administration is apparently moving from rule to result orientation, from systems to enterprise, from obedience to reward, from centralization to decentralization and from the duties of administrators to the rights of citizens.3Both in economy and polity an over hauling has taken place, altering totally theparadigm of governance, administration and development.4 A new paradigm has been developed by which new opportunities, which are uncommon, can be harnessed by enhancing the capacity of the stake holders. Through this paradigm power is given to the people to determine their destiny.5 People have been projected as the major stakeholders and they have to decide their course of action in the process of development. The government is no longer conventionalized as 'provider', but is instead envisaged as'facilitator' and therefore, is accorded a back seat, while the community or user group is expected to take the front in development initiatives.6Good Governance: Indian ExperimentFor the success of any event or programme a centralized drive is necessary toprepare the stake-holders to hold their hands on to it. It could be called a descent and ascent process.7Interestingly, the 73rd Amendment with the proclaimed objective of democraticdecentralization was not a response to pressure from the grass roots, but to anincreasing recognition that the institutional initiatives of the proceeding decades had not delivered the desired results of ushering equity and social justice. The growing conviction that big government cannot achieve growth and development in a society without people's direct participation and initiative heralded the enactments of the 73rd and 74th Constitutional Amendment Act and the subsequent state-wise Panchayati Raj Acts in India. This process of decentralization of power, provision for participation of citizens in local decision making and implementation of schemes affecting the livelihood and quality of life was pushed vigorously with the aim to accelerate thus the'top down', process of government to an interactive process and thus make inroads in to the internationally acclaimed standards of good governance.There emerged a political consensus that governance has to extend beyondconventional bureaucracies and involve actively citizen and consumer groups at all levels, to inform the public and disadvantaged groups, so as to ensure service delivery and programme execution through autonomous elected bodies.8 That the traditional government-citizen relationship, cast in a donor-recipient mould and the bureau-centric power focused approach, per force has to undergo change in the new scenario.Information: Tool for empowermentTransparency and accountability in administration as the sine qua non ofparticipatory democracy, gained recognition as the new commitments of the statetowards its citizens. It is considered imperative to enlist the support and participation of citizens in management of public services. Traditionally, participation in political and economic processes and the ability to make informed

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choices has been restricted to a small elite in India. Consultation on important policy matters, even when they directly concern the people was rarely the practice. Information-sharing being limited, the consultative process was severely undermined. There is no denying the fact that information is the currency that every citizenrequires to participate in the life and governance of society. The greater the access of the citizen to information, the greater would be the responsiveness of government to community needs. Alternatively, the greater the restrictions that are placed on 'access', the greater the feelings of 'powerlessness' and alienation. Without information, people cannot adequately exercise their rights and responsibilities as citizens or make informed choices. Government information is a national resource. Neither the particular government of the day, nor public officials, creates information for their own benefit. This information is generated for the purposes related to the legitimate discharge of their duties of office, and for the service of public for whose benefit the institutions of government exist, and who ultimately (through one kind of import or another) fund theinstitutions of government and the salaries of officials. It follows that government and officials are 'trustees' of the information of the people.Nonetheless, there are in theory at least, numerous ways in which informationcan be accessible to members of the public in a parliamentary system. The systemic devices promote the transfer of information from government to parliament and the legislatures, and from these to the people. Members of the public can seek information from their elected representatives. Annual reporting requirements, committee reports, publication of information and administrative law requirements also increase the flow of information from government to the citizen. Recent technological advances also help to reduce further the gap between the 'information rich' and the 'information'.10 However, in spite of India's status as the world's most populous democraticstate, there was not until recently any obligation at village, district, state or national level to disclose information to the people – information was essentially protected by the colonial secrets Act 1923, which makes the disclosure of official information by public servants an offence. The colonial legacy of secrecy, distance and mystification of the bureaucracy coupled with a long history of one party dominance proved to be a formidable challenge to transparency and effective government let alone an effectiveright to information secretive government is nearly always inefficient in that the freeflow of information is essential if problems are to be identified and resolved.Need for RTI LegislationInformation can empower poor communities to battle the circumstances inwhich they find themselves and help balance the unequal power dynamics that exist between people marginalized through poverty and their governments. This transparent approach to working also helps poor communities to be visible on the political map so that their interests can be advanced. The right to information is therefore central to the achievement of the Millennium Development goals.11Right to information legislation therefore acquired fundamental attention for the

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development of society. RTI laws gained prominence as critical tools to combatcorruption, and inefficiency. Although corruption exists in all societies, it has aparticularly pernicious effect on less developed countries. As also acknowledged by donor agencies, corruption discourages foreign investment and eats away at the budgetsallocated to public procurements which enable basic infrastructure such as roads, schools and hospitals to be built. It also debilitates political institutions by reducing public confidence in their operation. If unbridled corruption continues to infect a society or political system, it may eventually lead to social interest due to the division it creates between those who have easy access to goods and services and those who remain excluded. It is the poor who always bear the greatest burden of a corrupt society. Right to information legislation, is therefore, considered fundamental in furthering the development of society and in eradicating poverty. An unprecedented number of governments around the world with UNDP support are therefore increasingly enacting RTI laws. These laws vary enormously and often depend on the circumstances and specific campaigns, besides the development, and political contextor the places where they are launched. The right to information can be guaranteed in a number of ways. Many countries provide for the right in their constitutions, usually by means of a broad statement guaranteeing the right of access to information. In the context of India the constitutional right to freedom of expression is specified (Article 19(1)(a)) and the right to information is inferred from this constitutional right. RTI in India also received judicial recognition though some landmark judgements of the Supreme Court. Brick by brick the judiciary has built an impregnable edifice of the Fundamental rights providing thereby a semantic expansion and wholesome judicial connotation to RTI.In pursuance of the need to provide RTI and enhance transparency respectiveGovernments made and attempts to amend the Official Secrets Act (1923) In 1996 the first major draft legislation on RTI was circulated by the Press Council of India. This draft originated in a meeting of social activists, civil servants and lawyers in Mussoorie and culminated in the Freedom of Information Bill, 2000 introduced in Parliament. Meanwhile instead of waiting for a central legislation, half a dozen states enacted their own laws on RTI.State Level LawsTamil Nadu was one of the pioneer states to introduce the RTI Act on April 13,1996. The enacted legislation was full of exceptions and inadequacies and was not clear as to how the Act would apply to Panchayat Unions Municipalities and Panchayats. This uninspiring model definitely did not merit emulation.Goa was the second state to enact this legislation (Oct. 1997). Despite tallclaims made by the state government regarding transparency and opennness tostrengthen democracy, the Goa Act also ironically consisted of several peculiarprovisions, which allowed the state to withhold information without sustainable reasons for doing so. Vague exceptions and lack of clarity as to who would be the competent authority to furnish information were some of the deficiencies of this Act. Madhya Pradesh passed a bill a year later which was inexplicably sent for asset to the President. The assent never came.

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Rajasthan passed a bill in May 2000.Thereafter governments of Delhi, Karnataka and Maharashtra also enactedlegislations for RTI. But there has been observed a marked difference between all other8state legislations and that of Rajasthan. The distinguishing feature has been the demand for such Act made at the gross roots level by a Civil Society Organization (MKSS) in Rajasthan.Rajasthan ExperienceThe most important feature that distinguishes the movement for the people'sright to information in Rajasthan from that in other parts of the country is that it was deeply rooted in the struggles and concerns for survival and justice of the most disadvantaged rural people. It is necessary to point out how critical the difference in the perspective to RTI is when the demands emerge from the people (at the grassroots) and the suggestions of change emanate from policy makers and academics considering and debating political reform. While legislative and systemic change is the goal of both efforts, there is a vast difference in the focus and perspective not only in the demandbut also in the final outcome of such changes. The Rajasthan experience amplyillustrates that the demand for RTI emerging from a people's struggle is far moreincisive and has the potency to drastically alter the parameters of decision making and governance.The first political commitment to the citizen's Right to Information foundmanifestation on the eve of Lok Sabha elections in 1977 as a corollary to publicresentment against suppression of information, press censorship and abuse of authority during the internal emergency period of 1975-77. The Janata Party government in pursuance of its promise in its election manifesto to provide an open government constituted a working group of government officials to recommend modifications in the Official Secrets Act 1923. The 'no change' recommendations given by this group was although against popular expectations, indicative of bureaucratic inclination towards secrecy.Political commitment to RTI for the second time was the outcome of thefrustration of people over the earlier governments reluctance to disclose information relating to Bofors and other deals12 unfortunately, the subsequent National Front government's vociferous commitments towards RTI did not translate into any action whatsoever. The next multi-party coalition NDA at the centre fortunately succeeded in fulfilling its commitment, towards establishing 'transparent' and 'efficient' government by introducing the Freedom of Information Bill, 2000 in Parliament. It was the H.D. Shourie's Draft Bill which eventually got enacted under the name of Freedom of Information Act 2002. This Act was severely criticized for allowing too many exemptions, and absence of penalties for not complying with request for information. This Act thus did not meet the expectations of 'open government'.In 2004 Government of India appointed a National Advisory Council whichwith the support of NCPRI and the Common Wealth Human Rights Initiativeundertook the task of drafting the presently prevalent RTI bill.

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This draft which was presented to Parliament on 22nd December 2004 wasfinally passed on 12 October, 2005 only after more than a hundred amendments were initiated under pressure from civil society groups.Under the terms of this Act, any citizen may request a department of the Centralgovernment, State government or Public Sector Company or Bank for information on almost any question related to the department or company's functioning. The government body is expected to comply within 30 days, failing which the officials responsible for non-compliance faces financial penalties and, in persistent cases, jail terms. The Act also requires government bodies to publish certain specified information on website. This is considered to be a major milestone in the 'march from darkness of secrecy to down of transparency' and an important tool in the fight against corruption. Government officials continue to complain that the law goes too for and that by requiring them to disclose file. Nothing, it leaves them open to blackmail and intimidation. Critics have generally not been sympathetic to these claims contendingthat these are merely expressions to camouflage their frustration at having to perform under the glare of public scrutiny and being deprived of indulging in corruption. It is obvious that democratization becomes a difficult task especially so when the human collectivities that gain advantage from the existing form of governance turn against any form of reform in governance particularly in giving power to the people, as the existing order and practices would be challenged.Advocacy by Civil SocietyCivil society organizations known as 'third sector of democracy' have playedimportant roles in counter-balancing state, through monitoring their activities, all along demanding 'transparency' and 'accountability'. The lack of political will and reluctant and lackadaisical attitude of bureaucracy to recognize the people's Right to Information found substitution in CSO efforts towards this end.It is pertinent to mention that the first major draft legislation on RTI wascirculated by the Press Council of India in 1996. This draft was derived from an earlier one which had been prepared in 1995 at a meeting of social activists, civil servants and lawyers at Mussoorie. Another such detailed legislation for RTI was drafted by (CERC) ConsumerEducation Research Council.One of the most unique movements in this context is the Mazdoor Kisan ShaktiSansthan Movement (MKSS) in the state of Rajasthan. The most important feature that distinguishes the movement for the people's RT in this arid state of Rajasthan is that it is deeply rooted in the struggles and concerns for survival and justice of the most disadvantaged rural people.Ordinary People: Extraordinary EffortsUndoubtedly one of the biggest problems facing democratic institutions in Indiatoday is the dwindling interest and participation of people fuelled by the sense ofhelplessness citizen's face when relating to institutions of governance. It is in thecontext of this prevailing atmosphere of cynicism, apathy and despair that the story of the collective efforts to bring about political change by ordinary people in a small part of Rajasthan, becomes remarkable and significant.It is often assumed that right to information laws are only of interest to the

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urban elites, or those concerned with policy making. But one of the most imaginative campaign histories can be traced to this desert state of Rajasthan in India, in which agrassroots organization was able to successfully illustrate the link between lack of transparency and corruption. Its grass roots approach was able to convince people of the direct relevance of access to information on their everyday lives. This movement served as the inspiration for a national campaign and also motivated international efforts - ODAC in South Africa has used this model to challenge corruption in ruralIn 1994, this movement of MKSS broke new ground with experiments infighting corruption through the methodology of 'Jan Sunwai' (Public hearing) through which people have been able to voice their grievances towards government functionaries and expose arbitrariness and corruption in state bureaucracy. This movement sowed the seeds for the growth of a highly significant new dimension to empowerment of the poor, and the momentuous enlargement of their space and strength in relation to structures of the state.For years, indeed centuries, the people have been in their daily lives habitualvictims of an unremitting tradition of acts of corruption by state authorities graft,⎯extortion, nepotism, arbitrariness to name only a few but have mostly been ⎯silent sufferers trapped in settled despair and cynicism. From time to time, courageous 'whistle blowers' have attempted to fight this scourge and bring relief to the people. But in most such efforts the role of the people who are victims of such corruption has mostly been passive, without participation or hope. Such campaigns for the most part have arisen out of sudden public anger at an event, and died down as suddenly, or has been sustained, critically dependant on a charismatic leadership. Consequently, theresults of campaigns against corruption have been temporary and unsustainable.Breaching the walls of exclusionThe mode of public hearing (Jan Sunwai) initiated by MKSS, despite its localcharacter, has had state - wide reverberations and has considerably succeeded in shaking the very foundations of the traditional monopoly, arbitraries and corruption of the state bureaucracy. In these locally organized Jan Sunwais, expenditure statements derived from official records are read out aloud to assembled villagers. A panel of respected individuals from within and outside the area presides over the hearings wherein, local people are invited to give testimony which identifies discrepancies between the official record and their own experiences as labourers on public works, projects or applicants for means-tested anti-poverty schemes. Through this direct formof 'social audit' many people discovered that they had been listed as beneficiaries of anti-poverty schemes though they never received any payment. Others were astonished to learn of large payments to local building contractors for works that were never performed.The Jan Sunwai has turned out be a very powerful mode. It has been conductedin a comfortable, informal idiom of conversation and exchange. Yet it has all theseriousness and impartiality of court proceedings. Every Jan Sunwai has a panel of judges with independent credentials, who can ensure that the proceedings are

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fair, allowing everyone a bearing. Most importantly, this forum breaks the heavy reliance on the government for redressal.Despite confronting initial reluctance and resistance this momentous arduousstruggle led by MKSS in Rajasthan succeeded in compelling the government ofRajasthan to finally introduce the Right to Information law on 1st May, 2000.Undoubtedly this legislation was inordinately delayed, but once implemented itdid provide teeth to the empowerment of the common man.

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