3.2 Theoretical framework
3.2.1 Justification for the choice of the theories underpinning this study
3.2.1.2 Stakeholder theory
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approving the firm’s strategies and evaluating the control systems. The board usually hires an expert and knowledgeable body to oversee management activities on its behalf.
The audit committee is such a committee under the corporate governance framework to which the board delegates some of its oversight responsibilities. Chen et al. (2008) studied non-US companies trading shares in US market and argued that a competent audit committee could resolve the agency problems of foreign companies no matter which corporate governance model is in place in the company’s home country. Dey (2008) found that the level and intensity of the agency problem is less in those firms where the audit committee is more effective in terms of composition and functioning.
Abbott and Parker (2000) are of the view that once the audit committee is composed of independent, qualified members, the ability of management to manipulate such committee is limited if not eliminated thereby reducing agency costs and information asymmetry. It further informs the choice of agency theory as one of the theories underpinning this study.
Watts and Zimmerman (1990),several decades earlier, explained positive agency theory to mean linking managerial incentives to voluntary financial disclosure. Good financial reporting practices ensure more managerial disclosures (Choudhury, 2014). Thus, the financial reporting system has a role in resolving the agency problem. Since managers usually do not have to interact frequently with shareholders, it is appropriate for the communication gap to exist which will affect the level of trust between the parties. The audit committee can act as a bridge to such gaps (Islam et al., 2010). Hay, Knechel, and Ling (2008) assert that the audit committee serves in a complementary capacity to an external auditor in monitoring management activities. Chen et al. (2008) argued that an audit committee could help to maintain a healthy relationship in the contract between management and shareholders. The moment this is achieved, the practice of RAM may decrease while accountability and good corporate governance will become a culture in the corporate environment.
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recognise stakeholders whose relationship to the firm is primarily economic (Friedman, 1970). It is necessary to distinguish between stakeholders by their importance to the survival of the firm. Freeman identifies primary stakeholders as those that have a formal, official, or obligatory responsibility with the firm and all others are secondary stakeholders (Shankman, 1999). Clarkson made the distinction between voluntary and involuntary stakeholders based on exposure to or acceptance of risk-bearing activities with the firm (Clarkson, 1995). Regardless of the definition of stakeholder, this theory encompasses a relationship based on a two-way exchange; stakeholders are not only affected by the corporation but can also influence its activities as well. The most extreme proponents of this theory suggest that environment and future generation are in stakeholders (Peters & Bagshaw, 2014). Stakeholder theory presents the company as a separate organisational entity that connects to different parties in achieving a wide range of purposes (Fontaine, Haarman, & Schmid, 2006). Stakeholder theory is a theory of organisational ethics and management. In this theory, managers should not only maximise shareholders’ value but also enhance the profits of the stakeholder group.
Stakeholder theory adjusts or corrects the wrong impression found in agency theory that seeks to identify shareholders as the only interested party in a corporate setting (Harrison, Freeman, & Abreu, 2015). The structure of stakeholder theory widens agency problem to include several principals (Sanda, Mikailu, & Garba, 2010). Keay (2010) suggests that stakeholders include shareholders, employees, suppliers, customers, creditors, communities in the vicinity of the company’s operations, and the general public. Resolving the issues of which group of stakeholders deserve management’s attention is the concern of stakeholder theory (Peters & Bagshaw, 2014; Rawlins, 2006).
The theory argues that it is a social responsibility of the companies to consider the interests of all parties affected by their activities (Peters & Bagshaw, 2014). In the opinion of Freeman, Wicks, and Parmar (2004), an organisation that wants to be effective needs to consider every relationship that can affect or be affected by the achievement of its organisational objectives.
The objective of corporate existence, according to the stakeholder theory, is not the prerogative of the shareholders only (Freeman, 1984; Rampling, 2012). The close connection to corporate social responsibility (CSR), which is the mainstream of the corporate tendency, is an apparent contribution of the stakeholder theory. Literature and research argue that companies which concentrate on CSR are more likely to get
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acceptance and benefits (Rampling, 2012). It is, to some extent, beneficial to the corporation, in the long run, at least (Charron, 2007). The objectives of corporate governance have changed from the “maximisation of the interests of shareholders” to
“maximisation of the value of the company” (Rawlins, 2006).
In the opinion of Teixeira (2017), stakeholder theory promotes the emphasis of human capital, and the traditional theory holds that the owners of firms are the investors who provide capital for the firm. Accordingly, a company’s goal is to safeguard the investors’ interests. Here the word “capital” is limited to physical capital, but not human capital (Rampling, 2012; Teixeira, 2017). This argument was acceptable and suitable in the early era of large-scale industrial machinery-type operations, but is not appropriate and outdated in the current era of the knowledge economy (Rampling, 2012). The existence and development of the organisation are increasingly affected not only by the competence of managers but also by the advanced technological skills of the workers;
technology and other human capital contributions to the enterprise are far more impactful than the physical capital (Teixeira, 2017).
Charron (2007) states that stakeholder engagement are practices that the organisation undertakes to involve stakeholders positively in organisational activities. According to Phillips (1997) and Rawlins (2006), the involvement of stakeholders in a mutually benefiting scheme marks a person or group as a stakeholder and merits them additional consideration over and above that due to other individuals. In ideal terms, stakeholder engagement would take the Rawlsian form of a ‘mutually beneficial and just scheme of cooperation’ (Charron, 2007; Phillips, 1997; Rawlins, 2006). Companies need to remain relevant if they are to survive in a challenging business environment, and to be relevant requires regularly interacting with important stakeholder groups. A robust stakeholder engagement model is fundamental for companies to be able to understand and respond to legitimate stakeholder concerns (Rawlins, 2006). Charron (2007) asserts that such a view depicts stakeholder engagement as an excellent partnership of equals. However, it is likely that the organisation and its stakeholders are not of equal status and determining the terms of any cooperation are by a more powerful party (Rawlins, 2006).
Stakeholder theory owes its intellectual development to Freeman’s (1984) seminal work entitled, Strategic Management: A Stakeholder Approach. Until that time, management theorists were more or less in a constant struggle to establish the duties that corporations
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had, if any, to other groups besides shareholders and perhaps employees, suppliers and customers or groups whose relationship to the corporation was primarily non-economic.
Moreover, a search for a suitable justification for recognising such interests was still in development. It was not until Freeman's (1984) book that a general theory of the firm which included defining the concept of a stakeholder, providing an explication of the kinds of responsibilities that corporations had to stakeholders, and setting forth a suitable justification for such duties in managerial circles was widely accepted. Many articles and books use stakeholder theory as the central model of the firm (Donaldson &
Preston, 1995).
This argument for firm survival on the basis that firms have responsibilities to stakeholders for moral reasons justifies stakeholder theory. In this regard, stakeholder theory describes the firm as a nexus of cooperative and competitive interests possessing intrinsic value. It holds that individuals or groups with legitimate interests in the ongoing activities of the firm do so to obtain benefits (economic or otherwise) and that there is no prima facie priority of one set of interests over another. An implicit social contract between society and corporations which views the right to operate as an economic institution, as contingent upon upholding legitimacy in a pluralistic nation- state society, also justifies stakeholder theory (Donaldson, 1982). It has also been justified based on a corporation's social power or its ability to act in ways similar to individuals, thereby making it a moral agent and having the responsibilities that accompany this status (Davis, 1975). In all cases, the stakeholder theory of the firm establishes economic relationships within a general context of ‘moral’ management.