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CS Professional · Environmental, Social and Governance (ESG) - Principles and Practice · Concept of Governance in Professional Managed Company and Promoters Driven Company

Nirmaan Infra Ltd has no dominant shareholder; 90% of shares are held by thousands of retail and institutional investors, and a hired CEO runs the company. The board finds the CEO is expanding into unrelated businesses to enlarge his own empire, though returns are poor. Which classical theory best explains the governance problem?

Agency theory best explains it. Owners are dispersed and a hired CEO controls the company, so his personal aim of empire building diverges from shareholders' interest in returns. Governance mechanisms such as independent directors, monitoring and incentive alignment are designed to reduce this agency cost.

  1. AAgency theory, as managers' interests diverge from those of ownersCorrect
  2. BStewardship theory, as managers always act in owners' interests
  3. CResource dependence theory, as the board lacks external contacts
  4. DStakeholder theory, as employees were ignored

Explanation

Separation of ownership and control lets hired managers pursue personal goals such as empire building at the cost of shareholders, which is the agency problem. Stewardship theory assumes aligned interests, so it does not explain the conflict.

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