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Stewardship Theory or Agency theory : CEO Governance and Shareholder…
Stewardship Theory or Agency theory : CEO Governance and Shareholder Returns
Introduction
Strategic management and business policy has been influenced by agency theory
Managers will not act to maximized the return to shareholders unless appropriate governance structures are implemented in large corporation to safeguard the interest of shareholders
Shareholders interest considered will only safeguarded if the chair of the board in not held by the CEO or the CEO has the same interest as the shareholders through appropriate design incentive compensation plan
The paper seeks the contrast these 2 views about the governance and incentive of the CEO and subject them to empirical test
The discussion caution against too ready acceptance of agency theory model of CEO role and rewards
Introduce alternate approach to corporate governance of stewardship theory
Theory
In modern corporation, in which share ownership is wide held, managerial action depart from those required to maximize shareholder return
Agency Theory
Owners are principle and manager are agents and there is and agency loss which extent to which returns to the residual claimants
The owner exercise direct control of the corporation
Include incentive schemes for manager which reward them financially for maximizing shareholder interest
The kindred theory of organisational economics is concerned to forestall managerial opportunistic behavior - which include shirking and indulging in excessive perquisite at the expense of shareholder interest
If the CEO is the chair of the board the impartiality of the board is compromised
Interest of the owner will be sacrificed to a degree
There will be managerial opportunism and agency loss
Posit a clear separation of interest between manager and owners at the objective level
What motivates individual calculative action by managers is their personal perception
These theoretical consideration argue a view of managerial motivation alternative to agency theory and which may be termed stewardship theory
An implication of agency theory is that where CEO duality is retained
Shareholder interest can be protected by aligning the interest of CEO with suitable incentive schemes
Yield two hypotheses regarding CEO governance
CEO duality leads to lower returns to shareholders
Any observed positive effect of CEO duality are caused by long term compensation and are spurious
Stewardship theory
Manager under this theory far from being an opportunistic shirker essentially wants to do a good job
Holds that there is no inherent general problem of executive motivation
Holds that performance variations arise from whether the structural situation in which the executive is located facilities effective action by the executive
The issue become whether or not the organisation structure helps the executive to formulated and implement plan fro high corporate performance
Structure will be facilitative of this goal to the extent that they provide clear, consistent role expectations and authorize and empower senior management
Structures will assist them to attain superior performance by their corporation
CEO duality has been roundly criticized and call have been made to create separate incumbents of the roles of CEO and board chair to restore industrial performance and shareholder return
Yield two opposite hypotheses regarding CEO governance
CEO duality leads to higher return shareholders
The positive effect of CEO duality are not due to the spurious effect of long term compensation
Previous research
Relationship between whether or not the CEO and board chair roles were held by the same person and financial performance
Found a significant statistical association on ROE
only one out of three financial performance indicators they examine
But the report in unclear with the sign of relationship differing as between the text
This study must coded as weak and equivocal
Examined the relationship between CEO duality and organization performance
Support agency theory expectations about inferior shareholder return from CEO duality
Identifying corporation that got same CEO structure
Independence CEO structure pose higher return on equity, return on investment & profit margin
Made no control for industries in study
Thus desirable to assess effects of structure on shareholder return controlling for industry effect so there is need for a further study of the relation of CEO duality and its effect
The present study
Study an examination of the effect of CEO duality on shareholder return
Study aim to control for exogenous effect on shareholders
Study would use a longitudinal design and examine changes in structure and their effects on changes in shareholder return
Study is cross sectional in method makes causal inference less certain
The dual structure companies will likely include small minority who were independence
Lagged effect on shareholder return, it is the structure some years earlier which is the cause of present shareholder returns
Present structure will represent the true causal independent variable with some error.
Present test results will likely understate true effects of structure on performance but will be fairly reliable indication
Methodology
The sample is from convenience sample of 337 US corporation taken from a compensation survey based upon data drawn from Standard and Poor's Compustat Service Inc
Only 321 sample approved because the balance are incomplete data
Data check by reference back to and in some cases an ambiguity by contacting the company directily
Data sample covered wide range of industries and were classified into 7 industry
Size of data was operational as a number of employees and range from 50 to 915,000 employees
Thus this sample not represent random sample but fairly large and covers a range of organisation size, yielding variation
Board structure was binary code
Long term compensation was also coded as dichotomy and also compensation recorded by the survey additional
The present measure is conservative estimation if the impact of board structure on ROE
Shareholder returns were measure by return on equity
The measure of shareholder returns was gain in shareholder wealth by holding shares in corporation
For that reason these shareholder wealth measure used in this study is a conservative estimate of benefits to shareholders different board structure
Results
The average return on equity shows that dual CEO structures outperform independent chair structure
To control possible industry effects the different between ROE means was calculated separately for each of seven industry
The industry effect relatively when combine to give overall effect net industry, CEO duality structure still out perform independent chair structures significantly
Size not associated with ROE in these sample thus contrary to agency theory expectations
CEO duality is associated with higher return to shareholder than is an independent chair of the corporate board and support stewardship theory
Turning to financial incentives of the CEO it was not associated with higher ROE thus these incentive schemes for the CEO do not secure higher return to shareholders
ROE corporation with CEO duality and no long term compensation was only slightly lower than the average ROE of corporation with CEO duality thus hypothesis AH2 was rejected and SH2 was accepted
The superiority of independent chair board structure and CEO financial incentive on shareholder return as posited by agency theory was not on ROE
The positive relationship between CEO duality and shareholder return posited by stewardship theory was found on ROE
Since these result are apposite of those on ROE, the possibility arise that the present findings are due to the different size range of their and our study : being of large corporation and both large and smaller corporation respectively
Thus the superior shareholder wealth of the CEO duality structure cannot be explain as spurious of financial incentives
The long term compensation may also be attenuated for some reason - such as use of dichotomy rather than a continues variable which record the amount of long term compensation subsequently reveal more positive impact of long term CEO compensation on shareholder wealth
rather a positive relationship between CEO duality and shareholder wealth developed contrary to agency theory
Discussion
Present study finds that shareholder return in term of ROE are superior when there is CEO duality
Agency theory will only hold on if the correlation between duality and performance was the net result of that positive correlation and the negative effect of duality on performance hypothesis.
The observe correlation is positive between performance and duality cause the effect is positive and negative so it cancel the outcome.
In order the examine this question there is a need for future research to go beyond the present cross sectional design to longitudinal research design into causality
There may be long term positive impact of CEO duality on shareholder wealth which deserves further study
the effect of CEO duality on shareholder return and corporate performance generally may be contingent upon some institutional factors such as size or complexity
The motivation of managers is less problematic and more crucial factor influencing organizational performance and shareholder return is design of the organisational structure
Whether or not agency theory or stewardship theory more valid the question is more to the situational contingencies which define distinct theoretical domains
Thus the critical switching factor between agency and stewardship theories might whether the fundamental organisational coalition is secure or jeopardized
Implications for business and National policy
Given the lack of clear, consistent support in the U.S studies to date for the support benefit of non-executive board chairs, at present time it would be foolish for Australia to embrace the e notion that all companies have a non executive board chair
Conclusions
Paper outline two contrasting approaches to the structure of corporate boards
Agency theory & stewardship theory
Emphasizes control of managerial "opportunism" by having a board chair independent of the CEO
Stewardship theory stress the beneficial consequences on shareholder return of facilitation authority structure
The empirical evidence is that ROE returns to shareholders are improved by combining rather than by separating
Support the stewardship rather than Agency theory
Safeguarding of shareholder return with empowering manager to take autonomous executive action rather than placing management under control - will be better option
SETUPATHY RATHA KRISHNAN
ARTICLE : STEWARDSHIP THEORY OR AGENCY THEORY - CEO GOVERNANCE AND SHAREHOLDER RETURN