Corporate Governance

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2. 'When they were put to the test, corporate governance routines did not serve their purpose to safeguard against excessive risk taking.... the risk management systems have failed in many cases due to corporate governance procedures rather than inadequacy of [complex financial] computer models alone." With reference to the one of the theoretical models of the corporation you have studied consider: a) What, if any, are the legal obligations of directors of Australian companies generally to safeguard their company against excessive risk taking? The primary responsibility of the board of directors is to protect the shareholders' assets and ensure they receive a reasonable return on their investment at a given risk appetite. This is however, rarely the case. Directors are most likely to engage in excessive risk taking1 (Adler) to further their own personal interest and incentives at the expense of the company and its' stakeholders. Contractarian theory revolves around the notion that the corporation is deconstructed to reveal no more than a "nexus of contracting relationships" between managers, shareholders and other stakeholders.2 Its core innovation was to conceptualise the relationship between management and shareholders of a public company as a corporate contract in which wealth would be maximised as a result of atomistic market-mediated actions.3 The primary criteria behind contracting alternatives is one which secures the lowest agency cost. Such cost arises from the divergence in interest between the principal and agent and is inherent in any arrangements where there is a delegation of decision making authority from the principal to the agent with disparate personal utility.


The board's interests were in conflict the decision to expand did not only stem from the adequate performance base of the directors but also fuelled by their personal interest of greater remuneration. The ASX corporate governance principles outlined the preferable majority of independent directors for the establishment of remuneration committees so as to reduce the possibility of directors from making impaired decision creating substantially detrimental agency costs for the company.12 Consistent to contractarian beliefs, the market's 'invisible hand' brought into effect doctrinal constraints upon management such as to ensure the performance of the contract relationship between directors and shareholders in corporate governance. However, there are exceptional cases whereby market forces were seen to be insufficient to stimulate director's obligation to be properly manifested in Australian corporate governance practice. c) With reference to the theory you have chosen, consider why, and in relation to whom, we might want to improve the governance of risk taking by Australian boards of directors? Shareholders claims usually stem from them being the ultimate risk bearers in a company in that their financial claim are postponed to those of creditors in liquidation. They are the residual claimants on firm value, and delegate the corporate decision making to managers and the board of directors. Since their wealth is in the control of the corporation, they should be secured from the improper use of their investment capital by the directors through excessive risk taking. It is imperative that such confidence should be built as it helps attract further equity financing from shareholders.


As a checking and monitoring means, the utilisation of external audits provides a third party review of the mechanisms designed to minimise agency costs. They ensure that the behaviour of management, the board of directors and related parties are in the best interests of equity and debt holders and verifies the accurate communication of the company's financial position. 1 ASIC v Adler [2002] NSWSC 171 2 M C Jensen & W H Meckling, "Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure" (1976) 3 J Fin Econ 305, reprinted in Posner & Scott, p 39. 3 Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 1-39 (1991) 4 Corporations Act 2001 5 Corporations Act 2001, s180(2) 6 F H Easterbrook & D R Fischel (1989) 89 Colum L Rev 1416 7 Grant Fleming, Corporate Governance in Australia, Agenda, Volume 10, Number 3, 2003, p 195-212. 8 Wheelwright, E. (1957), Ownership and Control of Australian Companies: A Study of 102 of the Largest Public Companies Incorporated in Australia, The Law Book Co. of Australasia, Sydney. 9 Grant Fleming, n 7 10 Merrett, D. (2002), 'Corporate Governance, Incentives and the Internationalization of Australian Business', Paper to the Business History Conference, Delaware 2002. 11 Grant Fleming, n 7 12 ASX Corporate Governance Principles 8.1 13 Grant Fleming, n 7 14 R S Kaplan and D S Norton, "The Balanced Scorecard - Measures that Drive Performance", Harvard Business Review, January - February, 1992, p 71-79 15 Grant Fleming, n 7 16 W B, Jr Werther and D Chandler, Strategic Corporate Social Responsibility. Stakeholders in a Global environment, Thousand Oaks (California)- London, 2006, Pages 6 17 Gerald, n 7 ?? ?? ?? ?? 1

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