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CS Professional · Environmental, Social and Governance (ESG) - Principles and Practice · Conceptual Framework of Corporate Governance

Kaveri Power Ltd's shareholders worry that the CEO may take decisions to boost personal bonus rather than long-term value. The board therefore links a large portion of CEO pay to share price and appoints independent directors to monitor management. Which theory best explains this governance design?

Agency theory best explains it. It assumes managers as agents may pursue their own interests against shareholders as principals, so governance uses monitoring by independent directors and incentive pay tied to share value to reduce agency costs. Stewardship theory would rely on trust rather than such controls.

  1. AAgency theory, because it addresses the conflict between principals and agents through monitoring and incentive alignmentCorrect
  2. BStewardship theory, because it assumes managers are naturally motivated to serve owners
  3. CStakeholder theory, because it balances claims of employees and communities
  4. DResource dependency theory, because it views directors as links to external resources

Explanation

The fear that managers pursue self-interest at the expense of owners is the agency problem. Monitoring through independent directors and aligning pay with share value are classic agency-cost controls. Stewardship theory would instead reduce monitoring and trust managers.

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