Agency theory which has been developed to respond to the problems resulting from the separation of ownership and control of companies has dominated corporate governance research (Jensen and Meckling 1997; Daily et al. 2003). However, given the complex nature of corporate governance, different and competing theories including the resource dependence, stewardship, and stakeholder theories have also emerged from the management and strategic literature (Lajili and Zeghal 2010).
The agency theory regards the primary duty of boards as acting as an effective monitor of corporate management to ensure that management serves the best interests of the company’s shareholders (Fama and Jensen 1983). Thus, according to Fama and Jensen (1983), directors perform a monitoring role, which refers to the extent to which the directors control managerial decisions on behalf of the shareholders so as to reduce top managers’ opportunistic behaviours. Directors on the board can be executive directors, affiliate directors, or independent directors (Dalton et al. 1999) but according to the
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agency theory, only independent directors who do not have any relationship with the firms except being part of the board, are truly effective in monitoring the decisions of the firms’ management (Ashwin et al. 2016). Agency theory, therefore, regards boards of directors, particularly independent directors as those who prevent management from opportunism and their self-serving motives through effective monitoring. Monitoring by the board of directors lowers the agency problems, thereby limiting firms’ likelihood of financial distress (Hillman and Dalziel 2003).
From the resource dependence theory, a firm’s survival is dependent on its ability to establish control over its critical resources (Pfeffer and Salancik 1978). Where a firm lacks critical resources, it becomes reliant on the external environment, and this dependence creates uncertainty that is harmful because it obscures the firm’s control of resources and choice of strategies obstructing everyday functioning thereby affecting the firm’s performance and its likelihood of financial distress (Rivas 2012). When a firm can cope effectively with uncertainty, it leads to power (Pfeffer and Salancik 1978) and an increase in its survival likelihood. The resource dependence theorists suggest that one important function of the board of directors is its resource dependence role in providing resources and examine how board capital leads to the provision of resources for the firm which enhances its survival. According to the resource dependence theory, directors are expected to give advice and counsel, bring legitimacy and access to significant constituents outside the firm, serve as channels for communicating information between external companies and the firms, and help in strategic development (Haynes and Hillman 2010). Thus, from the resource dependence theory (Pfeffer 1973; Kiel and Nicholson 2003), the board of directors links their companies to the external environment, which reduces uncertainties and facilitates securing critical resources including finance, information, and reputation (Ntim et al. 2015).
The stakeholder theory considers the interests of all stakeholders in the governance of firms. Even though companies’ boards of directors are responsible and accountable only to their shareholders, such accountability exists only in a strict and narrow sense. With the mounting, public pressure due to the recent corporate scandals and environmental concerns, the concept of the responsibilities of firms has changed and broader corporate governance guidelines have emerged and this has resulted in a broader interpretation of the directors’ role and responsibilities (Pande and Ansari 2014). According to Gaur et al. (2015), to serve the interests of all the stakeholder groups, as the theory suggests, it is important to have representatives from the stakeholder group on the board, though
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identifying all stakeholder group is very difficult and an unrealistic work for managers. Although it is not totally clear how relevant the stakeholder theory is, in analysing board composition and its performance results at the very basic level, stakeholder theory also points to a positive linkage between board size, board competence, and firm performance, with the assumption that a larger and more competent board may be better able to protect the interests of different stakeholder groups (Gaur et al. 2015).
The stewardship theory takes a completely different view from the agency theory by suggesting that managers are necessarily trustworthy and good stewards of the resources entrusted to them, which makes monitoring under agency theory unnecessary (Davis et al. 1997). The stewardship theory regards managers as stewards of firms’ resources and sees the board of directors as the body that inspires and advises management. Proponents of stewardship theory assert that superior corporate performance is linked to a board that has many inside directors. This is because inside directors have a better understanding of the business, and view processes and decisions from a better location than outside directors who according to the stewardship theorists lack the knowledge, time and resources to monitor management effectively and this can affect firms’ financial performance and survival (Donaldson 1990).
The agency, resource dependence, stakeholder, and stewardship theories prescribe different board functions. For instance, the agency theory focuses on the monitoring and control role of the board, while resource dependence theory regards board role as not only giving advice to management but also assisting the firm secure access to significant resources. The stakeholder theory regards boards as representatives of the different stakeholder group, and the stewardship theory limits boards role to managerial empowerment and advice (Gaur et al. 2015). Given that the above theories prescribe different roles for the board of directors and different functions for other corporate governance mechanisms, this study takes a multi-theoretic approach and uses some of the prescriptions and assumptions of these theories to develop the research hypotheses. Generally, this study focuses on testing some agency, resource dependence, stakeholder, and stewardship theories assumptions to help predict the likelihood of firms’ financial distress (Lajili and Zéghal 2010).