Multi-theoretical Approach

The most prevalent theory in the literature of corporate governance is the agency theory (Beattie et al. 2012), however, a growing strand of research has raised concerns about the use of this theory as a sole underpinning for governance (Christopher 2010). Eisenhardt (1989) argues that the agency theory should be used with complementary theories. She stated that agency theory is subject to the criticism that it “presents a partial view of the world that, although it is valid, also ignores a

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good bit of the complexity of organizations” (p.71). Similarly, Christopher (2010) contends that agency theory does not capture the broader environmental affecting forces that have an impact on organizations. Clarke (2005) criticizes agency theory stating that it only tackles the economic relation between management and shareholders and thus fails to sufficiently encompass all the main factors influencing corporate governance good practices as well as the wider range of corporate relationships’ complexities that take place under different environmental market changes. The environmental influencing forces that might affect the organization include: legal issues, social issues, behavioural issues, ethical issues, regulatory issues and human resource issues (Christopher 2010). These forces are arguably “external and internal forces not normally captured in the contractual obligations between management and shareholders in an agency-oriented paradigm” (Christopher 2010, p.686).

To reach what is called an “extended governance paradigm”, Christopher (2010) argues that the agency-oriented model should be augmented through including two things. First, researchers should consider the wider environmental forces affecting firm’s operations and recognize “a wider set of contractual arrangements between management, the shareholders and an extended stakeholder base” (Christopher 2010, p.686). Second, the governance paradigm should be considered as “being a cycle that extends from the directional and monitoring role of the board, to the management and operational role of the chief executive officer and his management team, and to the assurance role of the external and internal auditor” (Christopher 2010, p.686).

In the same vein, Eisenhardt (1989) addresses the criticism of agency theory and remarks that researchers should use a multi-theoretical approach to capture the

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broader environmental forces that would impact on an organization. The need for considering such forces arises from “the increased sophistication and complexity of operations of organizations” (Christopher 2010, p.693).

Few studies have discussed the applicability of a multi-theoretical approach in the field of corporate governance. For instance, Hillman and Dalziel (2003) combines resource dependence and agency theories in an attempt to provide a better interpretation of how directors function in governance. They argue that theoretically combining agency and resource dependence theories in an integrative approach is important in order to capture the practical roles of the board in terms of monitoring and providing resources. This implies that using either of the theories separately would not provide a complete understanding of a board’s practices and its effective monitoring role. Hillman and Dalziel (2003) further contend that an integrative approach of these two theories would “help overcome a current myopia” within the literature of the two theories, where researchers have tackled one theory (agency/resource dependence) at the expense of the other in explaining the functions (monitoring/providing resources) of the board (p.383). Similarly, Lynall et al. (2003) integrate the resource dependence, agency, institutional and power theories in a multi-theoretical view to explain how board’s composition is likely to be shaped throughout the lifecycle stages of organizations. Young and Thyil (2008) propose a holistic model of governance which is able to incorporate internal along with other environmental factors (ethical, behavioural, legal, corporate strategic, sociological etc.) in an attempt to provide an understanding and explanation of the occurrence of certain behaviours and practices. Above all, Christopher (2010) proposes a multi- theoretical approach that encompasses in addition to the economic-based agency theory, the three management-based theories: resource dependence, stakeholder and

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stewardship. Whilst retaining agency theory as the main theory, he suggests that any shortcoming of one of the theories “can be complemented with another theory or group of theories” (Christopher 2010, p.690).

By the same token, some studies have suggested the integration of management-based theories with the agency theory to overcome the limitation of using one theoretical framework (Christopher 2010).

For instance, some have proposed integrating agency and stakeholder theories. Hill and Jones (1992) suggest that the agency theory could be reconceptualised from a nexus of contracts between an agent and a principal to a wider nexus between stakeholders. Others suggest that the agency theory should be “subsumed within a general stakeholder model of the firm” (Culpan and Trussel 2005, p.65). Examining the failure of Enron, Culpan and Trussel (2005) argue that both of the agency and stakeholder theories are valid theoretical underpinnings for this debacle. Specifically, they argue that in the case of Enron, agency theory would only be able to explain the opportunistic behaviours of managers and the consequences of such behaviours on shareholders; however, it has nothing to do with addressing the consequences for stakeholders and how their interests could be protected. In other words, agency theory is not able to provide a complete understanding of the Enron debacle as its main focus is on the agent-principal relationship between managers and shareholders. Culpan and Trussel (2005) added that the importance of using stakeholder theory along with agency theory, is because of the fact that more constituents than only managers and shareholders have either effected or been affected by the failure of Enron. For instance, Arthur Andersen, the external auditor of Enron, is one of the stakeholders of the firm and had “allegedly colluded with Enron officials and destroyed some financial documents related to its

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audit” (Fernando 2009, p.230). On the other hand, the management of Enron have not only hurt the interests of shareholders but also those of other stakeholders comprising employees, creditors, competitors, etc. (Culpan and Trussel 2005).

Cohen et al. (2008) suggest the integration of agency and institutional theories contending that a board and its committees might be fulfilling their regulatory requirements of monitoring (agency perspective), and “are merely fulfilling symbolic roles” (institutional perspective) (p.193). They argue that using the agency theory alone may not reflect the true and effective role that audit committees may play in the oversight process, as its perspective focuses on the outward form of the board and audit committee, such as independence, number of meetings, number of financial experts, etc. Institutional theory, however, “suggests that it is insufficient to focus on isolated audit committee or board surface characteristics in determining the driving factors that affect reporting quality. Rather, it is also necessary to consider the nature of the relationship between management and other corporate governance players” (p.195).

In the same vein, Hillman et al. (2000) argue that agency and resource dependence theories must be examined simultaneously for better understanding of the composition of boards and role of directors. Similarly, Hillman and Dalziel (2003) articulate that using any of these theories alone is insufficient and represents a theoretical weakness. They argue that agency theory focuses on the purposes of the board and its committees for monitoring without taking into consideration their capability of doing so. As such they contend that the effective monitoring role of the board will not be fully understood if their ability to monitor is not taken in consideration.

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In essence, there are a limited number of studies which have examined the integration of the theories of corporate governance, and the validity of the integration propositions suggested by these studies even need to be determined through testing real life organizational settings (Christopher 2010).