Corporate Governance Mechanisms

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Corporate governance mechanisms

Corporate governance mechanisms


Firms use the mechanisms of a corporate governance system to restrain or discipline the managerial decision-making process. This assignment would cover the implications of prior corporate governance literature on within-firm investment decisions, including the efficiency of internal capital markets. Two key theoretical model point to agency problems as the primary source of inefficient internal capital markets. Additionally, studies find that firms with characteristics indicative of relatively weaker governance structures tend to have greater agency problems. This is the reason why the work in this area hypothesizes a positive association between governance mechanisms and the efficiency of firms' internal capital markets. Therefore, all the issues and aspects related to Corporate Governance Mechanism have been discussed in detail.

Theoretical framework for Corporate Governance Mechanism

Corporate governance is the determination of the broad uses to which organizational resources will be deployed and the resolution of conflicts among the myriad participants in organizations. According to the researcher in 2005, corporate governance encompasses both the structure of power within each firm that determines the allocation of money (i.e., who gets the cash flow, who allocate jobs, who decides on research and development, on mergers and acquisitions, in hiring and firing CEOs, on subcontracting to suppliers, on distributing dividends or buying back shares or investing in original equipment) and responsibility (i.e., who is liable for wrongdoing, misuse of funds, or poor performance). Accordingly, some authors define governance as a system of incentives, authority relations, and norms of legitimacy (Adams, 2010, 107).

Corporate governance becomes particularly important when there is an agency problem involving members of an organization, and, this agency problem cannot be dealt with through an incomplete contract. On the one hand, in an idealized situation when there is no agency problem, all organizational members are motivated to maximize profit and minimize cost, which thus maximizes shareholder value. In addition, no governance is necessary to resolve disagreements or conflicting interests. On the other hand, in the real world, there are agency problems and concluded contracts are infeasible owing to bounded rationality and information asymmetries. Corporate governance, therefore, plays a pivotal role in allocating residual rights of control which are rights to decide how assets should be used, given that a usage has not been specified in an initial contract. Corporate control, within the framework of corporate governance, involves the rights to determine the management of corporate resources (e.g. the rights to hire, fire, and set the compensation of top-level managers). These rights are mainly determined by the ownership level and participation in management and the board (Becht, 2005, 122).

Monitoring mechanisms help fill the gap left by incomplete contracting, and, therefore, represent vital components of firms' governance systems. Multi segment firms can avoid some types of monitoring, such as external monitoring by debt holders or shareholders, with the use of an internal capital market. When financing occurs within the firm, headquarters retains asset control rights and headquarters has greater incentives to monitor the use of ...
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